Monday, December 19, 2011

How fees are destroying pension wealth in the UK

As readers of my blog will know, I frequently rant about fees charged by investment advisors.  In most cases, the people getting ripped off are individual investors.  But in a recent report on the UK pension system, it is revealed that fees paid to City advisors (the City is the UK equivalent of "Wall Street") are so high that in many cases the pension funds are paying all their gains out in fees.  And it's getting worse.

The average equity fund manager makes explicit that they are charging about 1.5% a year of the sum invested for their services, but additional hidden expenses average 0.3% a year and trading costs cut a further 1.4% off an investment. And the situation is getting worse, according to the analysis, which found that charges had increased by 9% in the last decade. The presentation added: "If the trend of diminishing returns and increasing costs continues we could soon expect negative returns on average."
The mind boggles.  There is absolutely no reason why fees should be increasing, furthermore, management fees should not exceed 0.5% for large funds.  The trustees of these pension plans need to start shopping around more.   I'll give them one piece of advice for free.  Try indexing.   It's cheap and it works.

How much has Buffet lost on BofA?

In typical NewsCorp form, a Wall Street Journal headline states that:

"Warren Buffett Is $1.5 Billion Underwater on His Bank of America Stock

Huh?  I said to myself, I didn't think Warren had bought B of A common - his recent deal involved preferred stock and warrants.

Reading a bit further into the article reveals that in fact that author is talking about Warren's position in warrants and not in common stock.  The headline is not only misleading, it's pretty inaccurate as well.  

As a side note, the funny thing though is that the Business Insider Blog presumably didn't read it all the way through when this post first appeared.  The article was rewritten with the apology that "This article originally stated that Buffett had lost money on his investment. We apologize for the error."

Anyhow, back to Warren's warrants.   To state that he is $1.5 Billion underwater is a bit of a stretch.  He bought 700 million warrants at a strike price of $7.14.  The current B of A stock price is currently about $5.00.  So  (7.14-5)*700 million = $1.5 Billion.


But this doesn't mean that he has lost $1.5 Billion on the options.  As my MBA students should know, how much an option changes in value for a $1 change in the underlying stock price is given by the option's delta.  Only if the delta equaled 1 would Warren's warrants have declined by $1.5 Billion.  


Valuing these long term options is pretty tricky, but if we assume a delta of say 0.5 (which is probably reasonably close) then the decline in value of Warren's warrants is about (7.14-5)*700*0.5 = $ 750 Million.  Still a lot of money, but not as much as reported before.


For extra credit - under what circumstances could these warrants have actually increased in value?  Hint (we'd need to see a major increase in one of the other Black Scholes inputs).  For even more extra credit - how would this change have affected his other investment in the preferred stock?





Tuesday, December 13, 2011

IPO outlook

Jay Ritter (my dissertation chair) talks about the IPO outlook.

Economists and their charts

A great article from the Beeb showing the favorite charts of various economists.  In each case the charts show how the euro economy in particular has declined.   Sounds a little dull, but this is a great way to see the Euro crisis in pictures.

LNKD has a forward PE of 300.

Via counterparties: LNKD is trading off 300 times forward earnings.  Either profits have to increase a whole lot or the stock price will have to fall.  I know which one I'd bet on.

Monday, December 12, 2011

Two must read articles on active management and fees.

Articles on active management and fees may sound a little boring, but let's be very clear here: two of the three most reliable ways to increase your retirement wealth involve 1) avoiding actively managed funds and picking index funds, and 2) never paying someone a fixed fee to manage your money.   

Ron at the InvestorCookbooks blog has two great posts on these topics.  First, more compelling evidence on the futility of active management.   And second, the effects of paying a 1% management fee to your financial planner.

And, in case you were wondering, the third way to increase your retirement wealth is to save more.  



Evernote - Inc. Company of the year.

Inc Magazine has just announced that  Evernote is its "Company of the Year".  The article is a great account of the perils of running a startup.

I am a huge fan of Evernote.  For those who don't know, it is a multi-platform app that basically allows you to remember everything.  Check it out.

Tuesday, December 6, 2011

Is the Administration's mortgage refinancing plan working?

Back in October, the Obama Administration extended the HARP (Home affordable refinance program) to allow homeowners to refinance if even if their mortgages were underwater.   This change had a direct effect on the mortgage market.  Specifically, mortgage securities with high coupons (where the homeowners were paying high interest rates) fell in value.  This was because the market anticipated that a greater number of these homeowners would be able to refinance their loans at lower rates.  Previously they had been unable to do so because their loans exceeded the value of their homes.   I blogged about this back then and it appeared to be a classic case of negative convexity in the MBS market.

Now comes the news that the market has largely recovered.  The amount of expected refinancings will fall far below those initially predicted, apparently in large part due to the decreased credit scores of many homeowners.

(note link to FT website will require you create a free account to view the article).

Why Apple's cheap

Felix has a good analysis of the current relatively low valuation of Apple stock.   The  key problem that Apple faces is the problem that all very large companies face - sustaining a high growth rate becomes much more difficult when you become huge.   Unlike many other large companies, Apple's source of profits changes from one year to the next - which means that the stock is really only as good as its next big product.

Put another way, at some point Apple will stop being a growth stock and become something more boring - like perhaps another past member of the large cap growth club - Microsoft.

Battle for the soul of capitalism

InvestorCookbooks really likes John Bogle's book - Battle for the soul of capitalism.   It's on my reading list.