Monday, July 23, 2007

The Hedge-Fund 'Clones' -

Hedge fund clones are designed to mimic the return on hedge funds without quite so high of expenses or minimums.

The Hedge-Fund 'Clones' -
"...the most common type of hedge-fund cloning, known as the factor model approach, works: Firms analyze a few years' worth of hedge-fund returns, often using data from hedge-fund indexes. The firms then essentially reverse-engineer those returns, using complex mathematical models to create a portfolio of easily traded investments that would have delivered the hedge funds' performance over that period.

That group of investments becomes the clone's portfolio for the next month. Then the process is repeated, typically each month, and the portfolio is revised."
Like the brownies on ATHF, it is doubtful that the clones will be able to match the real thing:
"Andrew Lo...whose research helped to spark clone products, says he has found that the clones will capture only about 40% of hedge-fund returns. One reason: Some hedge funds are especially hard to mimic, such as those that try to profit from events such as corporate bankruptcies, because they often hold hard-to-trade securities that are off-limits to clones."

Friday, July 20, 2007

Catching up on some interesting news/posts

Time to clean up my "desktop" a here are some of the interesting stories that have accumulated there: / Lex - Investment banks and private banking: "But surely investment banking and private banking are a natural fit? In the world’s fastest growing markets, the development of capital markets and the increase in personal wealth are interlinked. Arranging an initial public offering then managing the proceeds for the seller has obvious synergies: UBS estimates that between 8 and 9 per cent of new referrals to its private bank come from its investment bankers....Institutional asset management is, on the face of it, harder to justify. For one thing, tight regulatory restrictions to avoid conflicts of interest prevent banks from exploiting potential synergies."

DealBooks suggests Sears may be ready to buy Safeway. Personally I do not see many synergies, but who knows? DealBook also writes that Google is getting into wireless to the tune of a possible $4.6 billion deal.

Not all IPOs go up. Not only was Orbitz priced below its planned price range, it then fell further in the secondary market.

In the Washington Post Jim Angel (Georgetown Finance Professor) disagrees with, but can not persuade the author, as to what a reader should do with an "extra" $21,000. Jim, FWIW I agree with you! lol...

Fed Governor Kevin Warsh gave an interesting speech last month (yeah sorry I just got around to reading it this week) on Financial Intermediation and Complete Markets. It is best introduced by him with the following visual bite: "...I will discuss how liquidity and financial innovation are making markets more complete--or more precisely, less incomplete--than in earlier periods."

In an article that will assuredly be used in many finance classes, MSNBC compares and contrasts the Dow and S&P 500.

Time to run! Have a great weekend! :)

Do family firms disclosure more? or less?

Quick--more or less?

Answer: less.

If you said "less" you are correct. And will enjoy the article knowing you got it right!
If you said "more" you are incorrect and will get alot out of the article!

Chen, Chen, and Cheng examine"family firms:
" important organization form, it accounts for approximately 46% of the S&P 1500 firms.1 Family firms are characterized by the founding family’s concentrated ownership and the founding family members’ active involvement in firms’ management either as top executives or as directors."
There are many reasons why family firms may release information less differently than other firms. Again in the authors' words:
"Family firms’ unique ownership structure has important implications for their voluntary disclosure practices. First, family owners have longer investment horizons than other shareholders... This implies that: (1) the benefits of accelerating timely information...accrue less to family owners, and (2) family owners stand to bear the potential cost, such as proprietary costs or costs arising from managers’ emphasis on short-term rather than long-term performance.

Second, family owners’ active involvement in firms’ management results in lower information asymmetry between themselves and managers...the demand for information from non-family owners to monitor managers is lower due to the substitutive relation between direct monitoring and public disclosure....

The above arguments thus imply that family owners prefer less public voluntary disclosure."
The findings support the hypothesis for less voluntary disclosure:
"Based on 4,415 firm-years from the S&P1500 firms in the period 1996-2000, we find that family firms exhibit a lower likelihood of providing management forecasts than non-family firms. Specifically, the likelihood of voluntary management forecasts is 8.1 percentage points lower for family firms than for non-family firms, ceteris paribus. The lower propensity of voluntary disclosure in family firms is evident in both good news forecasts (9.0 percentage points lower) and bad news forecasts (5.4 percentage points lower)."
While fairly convincing, there is another explanation. I will call it the Adelphia Experience where the firm discloses less because the owners do not want to disclose anything and due to their large stake, they do not need to. Of course given the relative valuations of family firms this cynical view appears to be the important exception.

As many of you know my family owns a very small chain of grocery stores, what you may not know is that the owners (my dad and uncles) are also notoriously secretive about every financial number. So this one hits close to home.

Good read.

Chen, Shuping, Chen, Xia and Cheng, Qiang, "Do Family Firms Provide More or Less Voluntary Disclosure?" (May 2007). Available at SSRN:

Nike Delays Vick's Shoe After NFL Star Is Indicted -

Reputation matters. Good or bad. So it is no surprise that when the horrific charges against Michael Vick have been filed, Nike is now facing tough decisions.

Nike Delays Vick's Shoe After NFL Star Is Indicted -
"'Nike is concerned by the serious and highly disturbing allegations made against Michael Vick and we consider any cruelty to animals inhumane and abhorrent,' the company said in a statement yesterday. Nike added that it believes Mr. Vick should be 'afforded the same due process as any citizen' and hadn't yet terminated its relationship with the athlete at this time."
Obviously Vick is not the first celebrity endorser to run into trouble with the law. As a rule the stock prices of the firm drops on the news. To show this a few years ago I helped on a paper with Mike Russell and Betsy Drewniak that sure enough showed that when celebrity endorsers got into trouble, the stock prices of the firm whose product is being endorsed, falls.

The delay of the shoe line is a good example of how cash flows are negatively affected when the celebrity gets into trouble or has a poor performance.

Thursday, July 19, 2007

Cash and growth? Not a contradiction!

Growing with the Flow - Metrics - and Georgia Tech's Charles Mulford point out that growing firms often consume much cash and the growth must be financed, it is not always the case. In fact, for many firms cash flows actually increase as the firm grows.

A look-in:
"Growth is often considered to be a cash drain," says Mulford, director of the lab and professor of accounting at Georgia Tech, but "it is not necessarily the case that growth must be financed." Some companies, he says, actually generate more cash flow as growth accelerates."
Which, using the textbook language is to say that the "Additional Funds Needed" is negative due to growth in "Spontaneously generated funds."

Not surprisingly, this is especially true at what Taleb would call scalable firms such as software.

One more look-in:
"The researchers looked at 11 companies in a range of information-technology sectors (hardware, software, telecom, services, and semiconductors) and used Microsoft as the Big Kahuna of the sector. The software giant didn’t disappoint: its core operating growth profile and free cash growth profile clocked in at 59.3 percent and 41.8 percent respectively. That is, for every added dollar in revenue growth the company can be expected to generate 59.3 cents in core operating cash flow and 41.8 cents in free cash flow."
Not earth-shattering, but definitely worth discussing in a corporate finance class!!

Interview with Nassim Taleb at Bloomberg

Fooled by Randomness and The Black Swan are each great, thought provoking books. And to top that, Taleb never wears a tie, so he has to be a good guy! But seriously give him a listen. (Thanks to MoneyScience for pointing it out!)

MoneyScience Financial Intelligence Network : Podcast: Nassim Taleb at Bloomberg:
"Available at the Bloomberg Podcast Page, Nassim Nicholas Taleb, founder of New York-based hedge fund firm Empirica Capital LLC and author of 'The Black Swan: The Impact of the Highly Improbable,' talks with Bloomberg's Tom Keene in New York about Taleb's book, the writing process and the impact of unexpected events on financial markets.

Get the MP3 here."

Wednesday, July 18, 2007

How (and why) to invest in commodities

When we speak about diversification we always provide lip service to investing in assets with low correlations, but since most take this to mean different stocks (equities) we sometimes mention other assets but few know how to invest in these other assets such as commodities.

Because of that lack of knowledge SmartMoney looks at ways that investors can invest in commodities without having to trade actual commodity contracts.

Funds Allow Small Investors Access to Commodities (Pimco Commodity Real Return, Oppenheimer Commodity Strategy Total Return, Fidelity Select Energy, Excelsior Energy & Natural Resources) | SmartMo:

Let's begin with the why, as in "why would you want to buy commodities":

Shortest version: because they have a lower correlation with equities (see Greer 2000). Thus even if they offer lower expected returns, they can lower overall portfolio risk.

From SmartMoney:
"with the increasing globalization of the world you can't get diversification by just going outside your country. It's all about getting outside of equities.'"
The Smartmoney article goes on to suggest three ways to do this without actually buying the commodities.
  1. Buying equities--for instance buy oil companies or sector mutual funds that buy equities.
  2. Buy Exchange Traded Funds (ETFs) that invest in commodity indexes. (for instance see
  3. Buy mutual funds that buy commodities.

Economists puzzled by irrational eBay buyers -

Wow. I have not read the actual study, but if USAToday has it even half correct, this is some solid evidence that people do not always act rationally. I guess the alternative explanation will likely be that the bidder gets more utility (bragging rights?) by winning the auction.

Economists puzzled by irrational eBay buyers -
"Ulrike Malmendier, an economist at the University of California at Berkeley, tracked auctions of common items – things readily available online or in stores but offered on eBay at a discount.

Most economists assume these kinds of auctions are largely immune to the passions and unpredictabilities of ravenous bidders, she says. Simple bargain hunting, they hope, would bring out our inner homo economicus, someone who acts in their self-interest to get the best deal possible.

No such luck, she says.....

But this is where eBay users fell prey to what Malmendier and her coauthor, Stanford University economist Hanh Lee, call 'bidder's curse.' Apparently, some bidders grew so enthusiastic about winning the auction that they lost sight of the 'buy it now' price..."We found that in 43% of the auctions the bidders ended up paying more than the 'buy it now' price," Malmendier says."
43%? WOW! VERY interesting and a boost for behavioral finance.

Speaking of interesting findings, when looking for the actual article that the USA Today piece was based on (here is a "Very Preliminary" version from a few years ago), I stumbled upon this by Stefano Della Vigno and Malmendier. It looks at what people pay for gym memberships and how often they actually go. (Gym time!)

Tuesday, July 17, 2007

Hedge funds and performance

Given all the attention hedge funds have been getting over the past few years, it is good to be reminded occasionally that when measured against a proper benchmark most hedge funds do NOT outperform. The following is from Ramit Sethi writing at Iwillteachyoutoberich.

I Will Teach You To Be Rich » Behind-the-scenes New Yorker article on hedge funds reveals they aren’t so sexy:
"...people with access to hedge funds — even they may be getting substandard returns in exchange for their participation in hedge funds. This is just another example of investor psychology and the importance of realizing that people are not always rational with their investments."
Sethi also cites Malkiel and Saha:
"After examining results of now defunct firms, Malkiel and Saha found that between 1996 and 2003 hedge funds made an average return of 9.32 per cent, significantly less than the 13.74-per-cent average return of funds included in the published databases."
Defnitely a good reminder and definitely not what you would expect if you just listened to popular press.

Monday, July 16, 2007

SSRN-Corporate Governance and Firm Value: Endogeneity-Free Evidence from Korea by JungYong Choi, Dong Lee, Kyung Suh Park

Got thinking about class notes for the next semester today. One area where I wanted to firm up a bit was to get some new evidence that governance matters. I guess it was my lucky day since after looking at only 4 papers, I found this interesting piece by Choi, Lee, and Park. They look at the impact of buying by the Korean Governance Fund (a fund who claims to buy firms with poor governance and then improve governance in order to ern the positive returns associated with improved governance.

SSRN-Corporate Governance and Firm Value: Endogeneity-Free Evidence from Korea by JungYong Choi, Dong Lee, Kyung Suh Park:
"...unique experimental setting arises from the first target announcement of the so-called Korean Corporate Governance Fund. Since it has a stated goal of investing in companies whose stocks are undervalued due to governance problems and generating profits by actively addressing those problems, its target announcement serves as an exogenous shock to other firms that makes their stocks re-evaluated as a potential target based on the gains, if any, from improving the quality of their governance"
The findings? Governance matters!

A few look-ins:

Main finding:

"We find that, among other firms, those companies whose governance structure empowers corporate insiders at the expense of outside shareholders experience a more positive stock price reaction to the Fund’s first target announcement. This result is consistent with the existence of potential gains to outside shareholders from improving governance of those other firms"
How they measure governance:
"[The authors] measure the quality of governance using an index of 11 governance provisions.... However, to ensure that our results are not specific to those provisions, we employ two alternative indices,"
Does it matter?
"Figure 1 attests to the economic significance of the target announcement. The two announced targets, which themselves are a poorly governed company and thus confirm the stated strategy of the Fund, respectively experienced more than 70 and 120 percent stock price increases over the first several days alone after the announcement. This implies that the expected profits from correctly predicting the next targets were enormous among Korean investors"
Interesting...and definitely consistent with the earlier work of Black , Jang, and Kim. So yes it will be included in class notes :)

Choi, JungYong, Lee, Dong Wook and Park, Kyung Suh, "Corporate Governance and Firm Value: Endogeneity-Free Evidence from Korea" (July 9, 2007). Available at SSRN:

Sunday, July 15, 2007

David Wright Strikes it Rich with Vitamin Water » Smarter Sports Blog

This really does have finance content! it will make a nice story in class if nothing else...Sure David Wright (and the rest of the Met's power hitters) seem to be mired in a season long funk (maybe Hojo as batting coach can change things?), but do not feel too sorry for David. Seems he made about $20 million in a recent takeover!

David Wright Strikes it Rich with Vitamin Water » Smarter Sports Blog:
"When David Wright of the New York Mets agreed to do an ad for Vitamin Water last year, he didn’t take cash. Instead, he took 0.5% stake in the company."

Here is a bit more on the story.

Friday, July 13, 2007

At least a part of the reason

This is not a knock on autoworkers. If they can get paid above market rates, so be it. But when anyone asks why US auto manufacturers are having trouble, the search might begin by looking at some of these stats from over at
U of M Economics professor tackles tough question of UAW wages - Autoblog: "A tip sent us to the blog of Dr. Mark J. Perry, professor of economics and finance at the University of Michigan, who points out that hourly union workers at the Big 3 make on average 57.6% more in a year than a university professor with a Ph.D. Using figures from the automakers themselves, Dr. Perry tells us that a union worker at Ford makes $141,020/year including wages and benefits. A worker at General Motors makes $146,520/year and one at Chrysler earns $151,720/year"
Now that is not to say I would want to trade jobs and start making cars, but I have to conclude that pay cuts are probably necessary to make the US Big three more competitive.

Predicting equity volatility using Implied Volatilty

Predicting actual volatility using Implied Volatility
"In this paper the authors examine460 of the S&P 500 firms to demonstrate that: (1) implied volatility is a better forecaster of realized volatility than historic volatility or GARCH models and (2) the information content of implied volatility significantly decreases with liquidity."
Both points are important. The first says that markets are good at predicting future volatility, but the second shows the limits of markets where there is little volume (an important consideration given the large number options that rarely trade.

Be sure to check this one out! I know the authors ;)

Wednesday, July 11, 2007

A Whodunnit in the Hamptons - Ethics -

A Whodunnit in the Hamptons - Ethics -
"Graham J. Lefford, a former butler to American Idol creator Robert Sillerman, has agreed to a $66,200 settlement in an insider-trading case. The Securities and Exchange Commission had charged Lefford with trading on information he allegedly obtained from faxes sent to Sillerman in 2004, when Sillerman was closing a deal to buy a stake in Elvis Presley's estate."

Bigger Bang Better but Dividends better signal?

Bigger Bang - Investor Relations -
"When it comes to buying back shares, it pays to think big. Two recent reports — one from Morgan Stanley, the other from Citigroup — find that companies executing the biggest buybacks relative to market capitalisation see their shares rise more than the rest subsequently."
Which is interesting enough, but the real reason for inclusion are these two nuggets found late in the article. First:
"..there is an important geographical caveat. The share prices of British companies with the highest buyback yields have underperformed the market in the past three years, in contrast to their continental European peers with identical repurchasing characteristics. UK companies are traditionally perceived as "more shareholder focused than their European peers," Morgan Stanley's analysts note. So, when continental European firms embark on "what is perceived to be a value creating exercise...the potential upside is more significant."
and then secondly:
"Over the past ten years, the share prices of companies that consistently boost dividends have outperformed the market — including companies with buyback programmes — regardless of the relative size of the dividend or buyback. "Dividends are rightly perceived to be a much better indicator of management's long-term view of the health of their company..."

Three "take aways"
  1. Unlike some earlier research, this European-based study by two investment firms finds bigger buybacks are a better signal than small buybacks.
  2. The buybacks seem to be more important where governance is not as good.
  3. Buybacks have a positive effect, but dividends may be a better signal.

For more on buybacks, see some past articles.

Monday, July 09, 2007

SSRN-Collateralized Debt Obligations and Credit Risk Transfer by Douglas Lucas, Laurie Goodman, Frank Fabozzi

Talk about a timely article. Lucas, Goodman, and Fabozzi examine collateralized Debt Obligations in this short (and easy to follow) article that looks at how financial institutions can transfer credit risk.

SSRN-Collateralized Debt Obligations and Credit Risk Transfer by Douglas Lucas, Laurie Goodman, Frank Fabozzi: "
Two recent developments for transferring credit risk are credit derivatives and collateralized debt obligations (CDOs). For financial institutions, credit derivatives allow the transfer of credit risk to another party without the sale of the loan. A CDO is an application of the securitization technology. With the development of the credit derivatives market, CDOs can be created without the actual sale of a pool of loans to an SPE using credit derivatives. CDOs created using credit derivatives are referred to as synthetic CDOs."

One fairly long look-in:

"CDOs are created for one of three purposes:

* Balance Sheet A holder of CDO-able assets desires to (1) shrink its balance sheet, (2) reduce required regulatory and economic capital, or (3) achieve cheaper funding costs. The holder of these assets sells them to the CDO. The classic example of this is a bank that has originated loans over months or years and now wants to remove them from its balance sheet.....
* Arbitrage An asset manager wishes to gain assets under management and management fees. Investors wish to have the expertise of an asset manager. Assets are purchased in the marketplace from many different sellers and put into the CDO. CDOs are another means, along with mutual funds and hedge funds, for an asset management firm to provide its services to investors. The difference is that
instead of all the investors sharing the fund’s return in proportion to their investment, investor returns are also determined by the seniority of the CDO tranches they purchase.
* Origination Banks, insurance companies, and REITs wish to increase equity capital. Here, the example is a large number of smaller size banks issuing trust preferred securities directly to the CDO simultaneous with the CDO’s issuance of its own liabilities. The bank capital notes would not be issued but for the creation of the CDO to purchase them."
Lucas, Douglas J., Goodman, Laurie and Fabozzi, Frank J., "Collateralized Debt Obligations and Credit Risk Transfer" (2007). Yale ICF Working Paper No. 07-06 Available at SSRN: / Companies / Financial services - Moody’s slams private equity / Companies / Financial services - Moody’s slams private equity:
"Moody’s, the credit rating agency, will on Monday launch an attack on the booming private equity industry, criticising its increasing use of debt to buy companies and questioning its claims that listed companies are better off in private hands.

Moody’s voice adds to the growing chorus of US critics, which includes trade unions, politicians of both parties and some company executives."

Thursday, July 05, 2007

Assets Benchmarked to the S&P 500 Reach $4.91 Trillion; $1.32 Trillion Now Directly Invested: Financial News - Yahoo! Finance

Some interesting stats from Standard and Poor's.

Assets Benchmarked to the S&P 500 Reach $4.91 Trillion; $1.32 Trillion Now Directly Invested: Financial News - Yahoo! Finance:
"With $4.91 trillion benchmarked to it and $1.32 trillion directly invested, the S&P 500 continues to reign as the world's most followed and influential stock market index. According to Standard & Poor's Annual Survey of Indexed Assets for 2006, the amount of assets directly invested in all of Standard & Poor's indices now exceeds $1.53 trillion, including $106 billion invested in the S&P MidCap 400 and S&P SmallCap 600. Assets invested in Standard & Poor's family of global indices climbed 13.8% over the previous year."

Tuesday, July 03, 2007

Streets' Alpha Hunters at war with Beta Builders -- that's you - MarketWatch

I have not yet read the book, but I just ordered it (Bernstein's Capital Market's Evolving) thanks to Mark's emailing of the following from CBS:

Streets' Alpha Hunters at war with Beta Builders -- that's you - MarketWatch:
"Wall Street's high-tech "Alpha Hunters" (benchmark beaters) are in an aggressive psychological war with America's 95 million Main Street investors, the "Beta Builders," average folks who are happy with portfolios that match the market averages....Every day the Alpha Hunters go into battle, and you are their enemy in a cunning psychological battle that targets your mind; distracting, misleading, softening, disarming you. Alpha Hunters want you defenseless, the better to control your behavior, get you acting against your best economic interests.
Know your enemy: This book has no defensive strategies to help you Beta Builders protect yourselves against Alpha Hunters. No, it was written for Wall Street's Alpha Hunters on the attack. But you'll be better able to defend yourself knowing your enemy's strategies and weapons"
Looks interesting!

Monday, July 02, 2007

Heard off the street: When is inside trading not inside trading?

GThe Pittsburgh Post-Gazette looks at the Jagolinzer paper on insider trading that we discussed back in March. Not much of an update, but still interesting:

Heard off the street: When is inside trading not inside trading?:
"Executives who used 10b5-1 plans beat the market by 6 percent over the subsequent six months while executives who didn't use them beat the market by only 1.9 percent, Mr. Jagolinzer found. Moreover, when executives terminated the stock sale plan before it ran its course -- something the SEC permits them to do -- the stock price subsequently rose a meaningful number of times."

Here is a link to the Jagolinzer paper.

Thanks TF for the heads up on the newspaper article.

Reading list

I am not sure how it happened, but my book-picking skills have been in top form of late. So since so many liked the last list, here once again I have hit the jackpot with a series of really good books. So without further adieu, here are some of the books I am recommending right now:

Finance related:

The Black Swan: the Impact of the Highly Improbable by Nassim Nicholas Taleb. Wow. Not only does Taleb explain what I have wanted to say (some things just happen out of the blue and by their very nature are unpredictable) but he does so in a funny, entertaining, and remarkably sticky. Taleb sets much of what we rely on on its head. For instance, you will never think of stats the same way—you will find yourself thinking more about tails (uh, not like that;), well maybe?). Not only does this way of thinking have huge financial implications (consider managing a large fund, you may be hedged against things you can think of, but not other Black Swan events), it also should have implications in many many walks of life. For instance, before BonaResponds goes to a disaster area, we concede we can not prepare for what we did not know. Rather than plan for an infinite number of eventualities, we plan to be flexible enough to adapt to whatever happens. The same is true in most businesses, armies, governments, and even many personal dealings. VERY good and important book. BTW Be sure to read the Prologue. Even if the rest of the book were not included, I would have been happy with my purchase BEFORE page 1.

The Economic Naturalist: in Search of Explanations for Every Day Enigmas by Robert Frank (Cornell Economist). Good stuff. Reminds me of Freakonomics, but I think I like this one better (maybe because its Cornell, maybe because of the key role students played in the book, or maybe because the short essays better fit my limited attention span. For instance why are most beverage containers round but most dairy case items (milk and OJ for instance) predominantly sold in square containers. Or why do brides buy wedding dresses while grooms rent tuxes. Good stuff!

Non financial reading:

Innocent Man by John Grisham. Not sure where to start on this one. It is Grisham’s non fiction work on two men (the focus, and hence title, is on one of them) who were improperly convicted of a very violent rape and murder. In some ways it is this era’s To Kill a Mocking Bird or Black Like Me. Not From the treatment of prisoners, to the fallibility of police and courts, the book is eye-opening and disturbing. As an aside, I now see why when I was interviewed to be on a jury, one of the questions the lawyers asked was whether I had read the book.

Duel in the Sun: Alberto Salazar, Dick Beardsley, and America’s Greatest Marathon. It is hard to imagine a time when US marathoners dominated, but this was it. The book tells the engrossing story of the two going stride for stride from Hopkington to downtown Boston on a hot sunny day in April 1982. In exploring these 26.2 miles, the book also gives much background on each runner and shows what led to the race and what happened afterwards that so dramatically changed the lives of each runner and the sport itself.