Wednesday, August 26, 2015

How do we know that the market is going to open "up" (or "down")?

This is a pretty basic question that most finance folks will know the answer to.   How does the media know what the market is going to do when it opens?

Turns out, the information is coming from index futures contracts that trade before the market open.  These futures contracts allow investors to bet on the price of the index (Dow or S&P) at some point in the future.   A nice explanation is on investopedia.  You can see the state of futures contracts on most financial pages - CNBC for example.

Today, the prediction was correct.  The market opened above its prior close.

Tuesday, June 16, 2015

What level of fees should an investor (including a pension fund) pay?

I got an update about my retirement account yesterday from TIAA-CREF.   It was good news - apparently the fees are going down on an equity index fund and also on a bond fund.

Here's a snapshot of the statement.  My fees are now 0.06% and 0.07% for two index products.   Now that is what I call cheap!

It got me wondering, how much would the NC Pension Fund pay at these rates?

Assuming that the NC Pension Fund is about $90 Billion in assets, a 0.07% expense ratio would be about $63 million in fees.

Which raises the question: Why does the NC Pension Fund pay $500 million in fees?  It appears that the fund is overpaying by about $437 Million annually.

Sunday, June 14, 2015

Reform needed at the NC Pension Fund.

Andy Silton has a nice piece in today's N&O in which he criticizes the management of the state pension fund.  First - the information provided by the Treasurer's office is awful.   It is almost impossible to figure out where the money is invested and what the fees are and the information is always out of date.

Second, the Treasurer seems to be pursuing a "pick winners" strategy.   This is a fool's errand.   You can't reliably pick winners in today's financial markets.  All you will end up doing is paying high fees to so-called "experts" and getting average performance in exchange.   A mountain of evidence shows this to be true.

What is worse is that the pension fund continues to move into Private Equity and Hedge Funds - both of which are incredibly expensive and do not provide the return for the risk and costs.  As Andy correctly points out, the risk of these assets is understated because they don't trade daily in the markets.

I've been making these arguments for a few years now and during that time the fees paid by the pension fund have gone up from about $300 million/year to about $500 million/year.  

This isn't small change.   The state of North Carolina pays half a billion dollars a year to Wall Street firms who provide worse performance than if the State just indexed the money.  At some point you have to question whether the Treasurer actually understands basic finance.

Thursday, June 11, 2015

New editors of the Financial Review

A little shameless self promotion. Srini Krishnamurthy and myself are honored to take over as editors of the Financial Review.
The full details are over on the Poole College of Management site

The Financial Review website is here:

Thursday, June 4, 2015

The hidden risks in target date funds.

My dissertation chair and coauthor, Jay Ritter talks about some of the risks in target date funds.  His primary concern is that these funds tilt towards bonds which implicitly exposes the investor to more inflation risk.

I've blogged about target date funds before, and how they are like hotdogs, but not in a good way. 

Wednesday, April 29, 2015

It's a great quarter guys

My colleague Don shared this.   Apparently, more often than not, equity analysts will tell CEOs "it's a great quarter guys".

It is pretty common for "great quarter" stocks to tank shortly thereafter.

The fact that the analysts are so cosy with the CEOs of the companies that they cover says it all.   As I used to say to my students in my equity analysis course - you don't work for the company and you don't owe the company anything.  Your analysis must be at arms length, otherwise you risk suffering from Stockholm syndrome.

Thursday, April 23, 2015

Spoofing and and herd behavior

John Cochrane (of U. Chicago) has an enlightening post about the practice of spoofing (creating fake orders to lure other traders to do stupid things).   Suffice to say, Cochrane isn't a big fan of regulation that prevents traders from being dumb.   He's probably right.

Wednesday, April 22, 2015

NC Pension Fund Fees Approach $500 Million

Andy Silton does the math and reports that fees for the pension fund are approaching $500 Million.

Just so we are clear here, that's $500,000,000.

So what are we getting for all these fees?   Apparently not a whole lot of extra performance - which is no surprise to anyone who believes that markets are pretty efficient (they are).

Silton points out that otherwise the fund is in good health - which is good, but that doesn't make wasting hundreds of millions of dollars a year any less bad.

The question we should ask then is "how much should these fees be?"

I'd answer that for such a huge portfolio, 0.1% of assets is a good start, as I can pay only 0.18% for $3000 with Vanguard and it seems reasonable to assume that $90 billion would get some sort of discount.

So assuming $90 billion in the fund, 0.1% fee would yield $90 million in fees.  But even if you go with the Vanguard fee of 0.18%, we're still only looking at $162 million.   That's $338 million less that what we are paying.

Wednesday, March 11, 2015

Monday, March 9, 2015

Do CEOs time option grants relative to stock splits?

This post is based on a paper coauthored with Erik Devos of UTEP and Bill Elliott of John Carroll University.

To answer this question, we need a quick recap of options and splits.

Stock option grants frequently make up a significant portion of CEOs' compensation packages.  Typically an option is granted to the CEO "at the money" meaning that the strike price is set close to trading price of the stock.  If the stock price increases after the option grant, the value of the option will increase.  This is a standard property of call options and is the prima facie reason for granting them in the first place.

Stock splits are, by and large, cosmetic changes to the stock.  A 2 for 1 stock split results in each share of stock being replaced with 2 shares.   In such a split, the stock price should fall in half, so a $100 stock will split to two $50 stocks.   In reality, the $100 stock splits (on average) into two $51.50 stocks.   In effect a $3 or 3% gain in value occurs on the announcement day of the split.  The key thing to note here is that this is "on average".  Why this occurs is a bit of a mystery and beyond our discussion today.

So given these two factoids - options are granted at the money and stock splits result in a price increase (split adjusted) - when would a CEO most likely want to get an option grant?  
A. Before the split announcement.
B. After the split announcement.
C. The CEO shouldn't care.

If you answered A, then you'd be right - and this is supported by the data.

This figure shows the number of grants made relative to the split announcement.  Clearly, there is clustering before the announcement on day 0.  So what's going on?

Because a grant is granted "at the money", the 3% price bump that occurs on the split announcement results in an immediate increase in value for the holder of the option.  Therefore a CEO would prefer to get his/her options before the split rather than after it. 

But the story is more tricky - as this result holds for scheduled grants (grants which occur at a pre-determined time each year).  This means that in some cases the split announcement is being timed relative to the grant.

OK but so what?

On average, by granting before the split, a CEO will see his/her wealth increase by more than $450,000!   This is based on the size of the grant and the effect that a 3% stock price increase has on the value of the option.

In case you are wondering, CEOs also appear to time their stock trades relative to split announcements.

These findings are forthcoming in the Journal of Accounting and Economics in the following paper:

“CEO Opportunism?: Option Grants and Stock Trades around Stock Splits” 
Erik Devos, William Elliott, Richard S. Warr
Forthcoming: Journal of Accounting and Economics.

A copy is available for download on my website.

Friday, February 13, 2015

Flash Boys - my review

I finally got around to reading "Flash Boys" by Michael Lewis.   Bottom line, like a lot of non-fiction books, it is pretty good, but probably could be half as long.

The basic story, in case you haven't read it is as follows {SPOILER ALERT}

  • RBC Equity trader suspects that his trades are being front run  - someone is anticipating his moves and then picking off his juicy trades by jacking the price very slightly.
  • After much research (using LinkedIn and experts in fibre optic cables) he figures out the problem.
    • The fragmented nature of equity markets - there are more than 30 equity trading venues - coupled with the speed at which information flows from one market to another - allows high frequency traders to lure trades to one market then pull back depth and pick off the trade at the next market.
    • The solution is to slow down trades
  • RBC Equity trader quits his day job and creates a new exchange which works on the idea that by slowing down trading, you remove the advantage to the HFT guys.
  • After a slow start, the new exchange does really well, because people hate getting ripped off the by the HFT guys.   
  • The exchange is still going:
There are a couple of side stories.  Apparently someone is laying fibre from New York to Chicago.   Also a coder goes to jail for apparently stealing open source code from Goldman.  But really he wasn't a bad guy.

Overall, worth a read if you are interested in HFT, but if you are not, then it's a pretty geeky book and probably not worth the effort.

The broader takeaway from the book is that a huge amount of money is being made from HFT.   Because HFT isn't a value creating enterprise, and the stock market is basically a zero-sum game, this means that this money is coming from investors.  Investors who have money in pension funds and mutual funds etc.  People like me.

Bottom line.  To quote Josh Brown: "The way to defeat high frequency traders is to be a low frequency trader"

Thursday, February 12, 2015

Buffett's bet against a Hedge Fund manager

We're in year 6 of Warren Buffett's million dollar bet against Hedgie Ted Seides.   Buffett bet that the S&P 500 index would crush a portfolio of hedge funds hand picked by Seides.

So far, Buffett is correct.  The index is stomping on the hedge funds.

Of course, there's no surprise here.  If you are interested in long term capital appreciation a portfolio of indexed stocks will virtually always outperform a fund that is charging 2/20 and is run by people who think that they are smarter than the market.

What's amusing is that Seides is now coming up with excuses for why it's not a fair competition.  You can read them here

Thanks to my accounting colleague, Don for the link.

Wednesday, January 7, 2015

NC State Jenkins Online MBA is ranked #9 by US News.

Fantastic news today.  Our online MBA program is ranked #9 by US News.  From the beginning, we focussed on creating a very high quality experience for our students, and it's nice to see that this focus has paid off.

For details about the Jenkins MBA - check out this link.