Via my colleague, Steve Allen: apparently the average public pension fund assumes a return of 8%. As I've talked about before - pension funds should actually have two return assumptions - a rate for the return of the assets in the portfolio and a rate for finding the present value of the liabilities. The latter should be basically the risk free rate. Based on this, even fully funded pension funds that assume higher rates are not really fully funded.
All my pension fund posts are grouped under the label "pension funds"
Tuesday, May 29, 2012
Facebook still has some way to go...down that is.
FB closed around $29 today, but probably has some way to go according to Mark Hulbert. Hulbert bases his analysis on a study coauthored by my dissertation adviser, Jay Ritter, who is an expert on all things IPO. The conclusion of the analysis: Something around $13 would be more reasonable. Ouch.
HT: Reformed Broker.
On a separate note, Felix argues that the FB debacle should be of concern to all of us.
And finally, perhaps we should short it - here's the simple guide to shorting an IPO. HT: Finance at Tepper
HT: Reformed Broker.
On a separate note, Felix argues that the FB debacle should be of concern to all of us.
And finally, perhaps we should short it - here's the simple guide to shorting an IPO. HT: Finance at Tepper
Wednesday, May 23, 2012
Even more on the ugly side of Facebook's IPO
A nice article about the under-pricing that usually occurs for IPOs (but didn't occur for FB). With quotes from my dissertation adviser, Jay Ritter, and another excellent finance researcher, Jacqueline Garner (who's a friend of mine).
Kid Dynamite doesn't feel a whole lot of sympathy for people who participated in the offering...
My expectations for a huge first day pop were already tempered, but I kept my order for two reasons:
1) I was curious as to how retail investors would be treated, given the fact that the Syndicate seemed to be upsizing the deal to satisfy more demand and
2) I was a greedy pig clinging to the hope that I might get some free money shares – allocated IPO shares that would get a nice first day pop.
And here’s why this IPO was successful: because all of us greedy, ignorant retail investors who were willing to buy Facebook at any price STILL had every chance to escape with our hides intact.
And finally, it looks like FB may have behaved quite badly - and possibly violated Reg FD (a rule that prevents management from disclosing material information to only a select few investors). Joshua Brown has the story.
Tuesday, May 22, 2012
What does price support look like?
My colleague, Bart, sent me this screen capture of yahoo finance at 4pm on Friday. This is what price support looks like.
Monday, May 21, 2012
More on Facebook...
Felix Salmon talks about the Greenshoe, although he gets it slightly wrong (a rarity for Mr Salmon). The Greenshoe is the option to sell an extra 15% of the issue, it isn't about shorting the issue. The SEC allows the underwriters to take a naked short as they are making a market in the new IPO stock. It is the combination of these two things where the financial magic happens (see my Friday post).
From Twitter:
Link
From Business Insider:
"ZUCKERS"
From Twitter:
Link
From Business Insider:
"ZUCKERS"
Facebook - the hangover.
As I said on Friday, Facebook was going to trade below $38 today (Monday), sure enough:
This is probably the first, and last time that I will correctly call a stock price movement.
This is probably the first, and last time that I will correctly call a stock price movement.
Saturday, May 19, 2012
Facebook and the Greenshoe option.
On Friday, Facebook's IPO provided us with a fascinating case study on the effects of price support.
Here's the graph of the stock price for the day (note that it didn't start trading right away because of a snafu with Nasdaq's computers).
You'll see that the price basically bottomed out at $38, but never went below $38, which is where the price support kicked in.
With new buyers of the stock trying to sell, the underwriters posted massive buy limit-orders at $38 (a limit order is an order to buy at a specific price). Known as "price support" in the jargon (or more politically correctly "price stabilization") this is part of the underwriting service which, in exchange for their fee, the underwriters pledge to try to keep the price at or above the initial offer price. Doing so ensures that shareholders who bought the stock at the initial offering don't get taken to the cleaners which would be bad for everyone.
You can see the effect of the underwriting support here - where there is a huge block of trades right at $38 and the result of the "epic battle" here.
You might be thinking that the underwriters just got the short end of the stick here - they've had to buy huge amounts of the stock at $38, knowing full well that the stock is likely to go down further on Monday when the market opens again. But you'd be wrong. At the end of the Friday, it is unlikely that the underwriters are actually holding any Facebook stock.
The way the underwriters do this is to use two tricks. First is the Greenshoe option (named for the company where it was first used, which is now StrideRite). The Greenshoe, or more technically, over-allotment option lets the underwriter sell 15% more shares than are listed in the offering. The second trick is that the underwriter is allowed to sell shares that it doesn't own - it can create a naked short position - so in effect, 15% of the shares sold to the public don't actually exist. (a naked short is when you sell something you don't own, as opposed to a regular short where you first borrow the stock and then sell it.)
So the underwriter has sold 15% extra shares (which don't exist!). If the price goes up, then the underwriter will exercise the Greenshoe option and get another 15% of real shares from the issuer to cover those naked short shares. But, if the price falls, as was the case for Facebook, the underwriter will just start buying back shares to cover the naked short. In theory the underwriter can buy back 15% of all the shares issued, and at the end of the day have a net position of zero.
The flexibility of being able to take a naked short position combined with the Greenshoe option ensures that the underwriter can provide aggressive price support without actually having to end up owning a ton of stock.
But on Monday it will be a different story. Once the underwriters have exhausted the 15% that they shorted, they will be unlikely to take one for the team and continue to provide support. My prediction is that the price will fall, because fundamentally, I don't think Facebook is worth $100 billion.
Here's the graph of the stock price for the day (note that it didn't start trading right away because of a snafu with Nasdaq's computers).
You'll see that the price basically bottomed out at $38, but never went below $38, which is where the price support kicked in.
With new buyers of the stock trying to sell, the underwriters posted massive buy limit-orders at $38 (a limit order is an order to buy at a specific price). Known as "price support" in the jargon (or more politically correctly "price stabilization") this is part of the underwriting service which, in exchange for their fee, the underwriters pledge to try to keep the price at or above the initial offer price. Doing so ensures that shareholders who bought the stock at the initial offering don't get taken to the cleaners which would be bad for everyone.
You can see the effect of the underwriting support here - where there is a huge block of trades right at $38 and the result of the "epic battle" here.
You might be thinking that the underwriters just got the short end of the stick here - they've had to buy huge amounts of the stock at $38, knowing full well that the stock is likely to go down further on Monday when the market opens again. But you'd be wrong. At the end of the Friday, it is unlikely that the underwriters are actually holding any Facebook stock.
The way the underwriters do this is to use two tricks. First is the Greenshoe option (named for the company where it was first used, which is now StrideRite). The Greenshoe, or more technically, over-allotment option lets the underwriter sell 15% more shares than are listed in the offering. The second trick is that the underwriter is allowed to sell shares that it doesn't own - it can create a naked short position - so in effect, 15% of the shares sold to the public don't actually exist. (a naked short is when you sell something you don't own, as opposed to a regular short where you first borrow the stock and then sell it.)
So the underwriter has sold 15% extra shares (which don't exist!). If the price goes up, then the underwriter will exercise the Greenshoe option and get another 15% of real shares from the issuer to cover those naked short shares. But, if the price falls, as was the case for Facebook, the underwriter will just start buying back shares to cover the naked short. In theory the underwriter can buy back 15% of all the shares issued, and at the end of the day have a net position of zero.
The flexibility of being able to take a naked short position combined with the Greenshoe option ensures that the underwriter can provide aggressive price support without actually having to end up owning a ton of stock.
But on Monday it will be a different story. Once the underwriters have exhausted the 15% that they shorted, they will be unlikely to take one for the team and continue to provide support. My prediction is that the price will fall, because fundamentally, I don't think Facebook is worth $100 billion.
Wednesday, May 16, 2012
Is Facebook fairly priced?
So here is my valuation of Facebook.
Based on trailing earnings of $1 billion and an expected market cap of $100 billion we get a trailing PE of 100.
As a comparison, Apple's PE is about 13 and Google's is 19.
It's really not worth spending much more time on this. Facebook is likely to be crazily overpriced.
The next question (as posed to me by my friend Robert) is : "do we short or buy puts?"
Based on trailing earnings of $1 billion and an expected market cap of $100 billion we get a trailing PE of 100.
As a comparison, Apple's PE is about 13 and Google's is 19.
It's really not worth spending much more time on this. Facebook is likely to be crazily overpriced.
The next question (as posed to me by my friend Robert) is : "do we short or buy puts?"
Tuesday, May 15, 2012
Facebook IPO - yawn...
In case you've been living under a rock, Facebook's IPO is scheduled for Friday. As Felix Salmon notes, there has been much talk about whether you should buy some of the stock.
Let's be clear here. For individual investors, it will near impossible to buy the IPO at the issue price. But to buy the IPO at the post issue price (once it begins trading) is a bad idea. History shows that on average, IPOs purchased on the first trading day significantly underperform similar stocks in the long run.
Just stick to indexing.
I've posted a lot on this before - here
Gene Fama talks about efficient markets
Great short interview with the so-called "father of modern finance".
Quote: Active management is a negative sum game.
Quote: Active management is a negative sum game.
Tuesday, May 8, 2012
Monday, May 7, 2012
An interesting take on floating rate notes
There's been some discussion of whether the Treasury should issue floating rate notes. Some people argue that doing so would expose the government to interest rate risk, but as this blog posting points out, this risk is already present in the current way that the government issues short term debt.
An interesting piece and worth the read.
An interesting piece and worth the read.
Friday, May 4, 2012
A great explainer of Shiller's 10 year PE ratio
Robert Shiller (Yale Economist) computes a 10 year PE ratio which aims to smooth out short term earnings fluctuations to give a longer run view of market valuation. The following is a really great explanation of this metric and some its uses.
My only quibble with the article is the bit about the level of the PE and the return on Treasuries. This is basically the argument of the so-called Fed Model, which is on pretty shaky ground from a theoretical perspective. I won't rehash the issue now as I've talked about this before here and here.
My only quibble with the article is the bit about the level of the PE and the return on Treasuries. This is basically the argument of the so-called Fed Model, which is on pretty shaky ground from a theoretical perspective. I won't rehash the issue now as I've talked about this before here and here.
Thursday, May 3, 2012
How is financial reform coming along...?
How timely - just as I posted on the financial reform of Wall Street (or lack thereof), Felix Salmon has a post on the same topic - much more informative than mine of course. He actually cites people in the know!
Money Power and Wall Street - a few thoughts
I caught the final episode of Money Power and Wall Street on Frontline last night (thanks to my DVR). If you missed it you can watch it on the PBS website.
Overall, I thought it was pretty good. The documentary showed that private derivatives - custom made for a client - make up the largest part of bank's profits. In particular the documentary focused on interest rate swaps and the numerous municipalities (here and abroad) that had been caught out after buying one of these things.
I was actually pretty surprised at how naive some of the buyers of these swaps were. Basically they were swapping a higher fixed rate for a lower variable rate. This is fine as long as rates stay low, but of course when the financial markets collapsed, all rates (except the US government bond rate) went through the roof. In my opinion, municipalities have no business swapping fixed payments for variable rates. In effect they are saying, "hey - we'll take the interest rate risk in exchange for lower payments today". That's not the job of local government. Of course the slick sales force of the banks coupled with a little bit of bribery helped make the case for these products.
The complexity and vastness of the wall street machine also was pretty apparent and that this complexity makes it incredibly hard for regulators to keep up with new products and markets that are being developed all the time. In addition, the global nature of the banking business means that many banks could just move part of their derivative shops to London to avoid the closer scrutiny of US regulators.
Going forward, it was clear that nothing has really changed. The Dodd Frank Act is unlikely to change much behavior, and the incentives to make large amounts of money quickly will no doubt drive yet another generation of bankers to create ever more elaborate products to sell to unsuspecting customers.
Personally, I think we should reinstate Glass Steagall and separate out commercial banking (loan making etc) from investment banking. I also think that we should impose increasing capital requirements on banks that increase with the size of the bank to make it costly to be too big to fail. Finally, I think investment banks should go back to being organized as partnerships and not as corporations. Under the partnership model, the partners were always on the hook for the risks taken by the bank.
I have zero confidence in any of these things happening however.
Overall, I thought it was pretty good. The documentary showed that private derivatives - custom made for a client - make up the largest part of bank's profits. In particular the documentary focused on interest rate swaps and the numerous municipalities (here and abroad) that had been caught out after buying one of these things.
I was actually pretty surprised at how naive some of the buyers of these swaps were. Basically they were swapping a higher fixed rate for a lower variable rate. This is fine as long as rates stay low, but of course when the financial markets collapsed, all rates (except the US government bond rate) went through the roof. In my opinion, municipalities have no business swapping fixed payments for variable rates. In effect they are saying, "hey - we'll take the interest rate risk in exchange for lower payments today". That's not the job of local government. Of course the slick sales force of the banks coupled with a little bit of bribery helped make the case for these products.
The complexity and vastness of the wall street machine also was pretty apparent and that this complexity makes it incredibly hard for regulators to keep up with new products and markets that are being developed all the time. In addition, the global nature of the banking business means that many banks could just move part of their derivative shops to London to avoid the closer scrutiny of US regulators.
Going forward, it was clear that nothing has really changed. The Dodd Frank Act is unlikely to change much behavior, and the incentives to make large amounts of money quickly will no doubt drive yet another generation of bankers to create ever more elaborate products to sell to unsuspecting customers.
Personally, I think we should reinstate Glass Steagall and separate out commercial banking (loan making etc) from investment banking. I also think that we should impose increasing capital requirements on banks that increase with the size of the bank to make it costly to be too big to fail. Finally, I think investment banks should go back to being organized as partnerships and not as corporations. Under the partnership model, the partners were always on the hook for the risks taken by the bank.
I have zero confidence in any of these things happening however.
How unbiased are financial advisors?
Not very - according to a well crafted double blind study. (Full paper here).
The study found that too often advisors took clients portfolios and re-worked them in ways that would earn them the highest commissions.
My advice: Index. Fees and commissions are very detrimental to your wealth.
The study found that too often advisors took clients portfolios and re-worked them in ways that would earn them the highest commissions.
My advice: Index. Fees and commissions are very detrimental to your wealth.
The multimillionaire men of Lehman
What the top 51 non-C level employees of Lehman made. Notably there is only one woman in the list.
Quote:
One can’t help but suspect that the all-male culture at the upper reaches of Lehman was a corrosive and damaging thing, which in some way helped lead to the bank’s demise.
Quote:
One can’t help but suspect that the all-male culture at the upper reaches of Lehman was a corrosive and damaging thing, which in some way helped lead to the bank’s demise.
Tuesday, May 1, 2012
10 things your commencement speaker won't tell you
With graduation around the corner, here's one from the Wall Street Journal.
Quote: Is that pretty girl Phi Beta Kappa? Marry her.
Actually that's what I did and it's worked out pretty well.
Thanks to my colleague Melissa for the link.
Quote: Is that pretty girl Phi Beta Kappa? Marry her.
Actually that's what I did and it's worked out pretty well.
Thanks to my colleague Melissa for the link.
Black Scholes caused the crash?
In an interview on Radio 4 (the UK's equivalent of public radio), Ian Stewart, a Maths prof from Warwick Uni in the UK argues that the Black Scholes equation was a "dangerous invention". This argument has been trotted out numerous times, and frankly it is pretty silly. It's like saying that the Wright Brothers are responsible for airliner crashes.
The article talks about LTCM (Long Term Capital Management) and how the failure of that hedge fund was in part due to its usage of Black Scholes. I disagree. The failure of LTCM was due to excessive leverage. The recent market crash also had little to do with Black Scholes, but was again due to excessive leverage by banks and people as well as a complete failure of risk management.
I've posted on this before - here and here. I am sure this isn't the last we'll here of this.
The article talks about LTCM (Long Term Capital Management) and how the failure of that hedge fund was in part due to its usage of Black Scholes. I disagree. The failure of LTCM was due to excessive leverage. The recent market crash also had little to do with Black Scholes, but was again due to excessive leverage by banks and people as well as a complete failure of risk management.
I've posted on this before - here and here. I am sure this isn't the last we'll here of this.
NC Treasurer race - why fees are what really matter.
The local ABC channel (11) reported last night that the NC Treasurer's office has uncovered wide spread fraud among retirees. Examples include retirees boosting their income in their last year of work and double dipping by retiring and then returning to work too quickly.
An officer for the Treasurer's office claims that in the later case alone, they've uncovered $1 million of fraudulent payments. While this is good news, lets get things in perspective. The state of NC Pension Fund pays over $300 million in fees to Wall Street and still underperforms its peers. The average management fee for the fund is around 50 basis points (0.5%), which might seem low, but for a fund of this size, this is ridiculously large. The state should be paying well under 10 basis points. Remember that 1 basis point of $70 Billion is $7 million!
While stamping out fraud is good, the place to look for real savings is in the fee structure of the fund. It is for this reason that I'll be voting for Ron Elmer in the May 8 primary for NC Treasurer. He's pledged to cut management fees by $50 million in his first year or he'll work for free. You can read more about his plan here.
You can also check out Ron's website here. You can also visit him on Facebook.
Disclosure: This blog is my personal blog, posts on it reflect my own personal opinions and do not reflect the views of my employer. I wrote and posted this on my own computer on my own time.
An officer for the Treasurer's office claims that in the later case alone, they've uncovered $1 million of fraudulent payments. While this is good news, lets get things in perspective. The state of NC Pension Fund pays over $300 million in fees to Wall Street and still underperforms its peers. The average management fee for the fund is around 50 basis points (0.5%), which might seem low, but for a fund of this size, this is ridiculously large. The state should be paying well under 10 basis points. Remember that 1 basis point of $70 Billion is $7 million!
While stamping out fraud is good, the place to look for real savings is in the fee structure of the fund. It is for this reason that I'll be voting for Ron Elmer in the May 8 primary for NC Treasurer. He's pledged to cut management fees by $50 million in his first year or he'll work for free. You can read more about his plan here.
You can also check out Ron's website here. You can also visit him on Facebook.
Disclosure: This blog is my personal blog, posts on it reflect my own personal opinions and do not reflect the views of my employer. I wrote and posted this on my own computer on my own time.
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