Quitting while they’re behind

THE past few years have been “as miserable as I can remember”, says Johnny Boyer of Boyer Allen Investment Management, a British hedge fund focused on Asia. The fund, which looked after $1.9 billion at its peak, faced the prospect of spending the next few years trying to claw its way back to pre-crisis asset levels. Instead the founders decided to shut the fund and give investors their money back.

Others have also had enough. “I’ve been doing this for 15 years and I’ve never seen as many people give up as in the last three months,” says Luke Ellis of Man Group, a large listed fund. This trend is distinct from the round of closures in 2008. Then, managers were hit by investors’ redemptions and had no choice but to close; today many are electing to walk away.

For some managers, the markets have become too stressful. Running a hedge fund today is “three times as much work for a third of the fun,” says one. But many are motivated by economics. Hedge funds typically get paid a 2% management fee on assets to cover expenses and a 20% performance fee on the returns they achieve for investors. Most funds do not earn performance fees unless they outperform their peak level or “high-water mark”. At the end of 2011, 67% of hedge funds were below their high-water marks, according to Credit Suisse, and 13% have not earned a performance fee since 2007 or earlier.

Funds can survive off a management fee for a couple of years, but four is a long time to go hungry. Most managers were banking on a recovery in 2011 but the average hedge fund slid by 5.2%—much worse than the S&P 500, which returned 2%. Poor performance is causing changes in the way the industry markets itself (see article). It also means many funds will have to wait even longer to earn a performance fee again. According to Morgan Stanley, 18% of hedge funds are more than 20% below their high-water marks.

Smaller funds have been more likely to close than their larger peers. That’s partly because it used to be possible to run a hedge fund with $75m under management. Today funds need at least double that amount because administrative and compliance costs are higher than ever. Larger funds also depend less on performance fees because their management fees bring in so much cash. John Paulson, a hedge-fund giant whose flagship fund was clobbered last year, has pledged to make up investors’ losses but his fund is so large that he can easily afford to carry on. That risks distorting the original point of hedge funds—that they are small, limber operations which come and go often (see chart).

For investors, it is generally a good thing if underperforming managers are returning cash and not milking them for fees. But others worry that high-water marks could skew funds’ investing decisions. Managers who have not earned a performance fee in years could take bolder bets to get back into the black. Leverage levels have been creeping up. Some may prefer to go out with a bang, not a whimper.

Plunge in Volatility Product a Warning to Investors

What happens, when you chase returns, the risk increases! Aivars Lode

By Reuters

Friday, March 23, 2012  

NEW YORK (Reuters)—After losing more than half of its value in the past two days, the plunge in the TVIX volatility-linked exchange-traded product should serve as a warning to investors before jumping into these high risk, esoteric products.

The VelocityShares Daily 2x VIX Short-Term exchange-traded note fell nearly 30 percent on Friday [March 23], following a 30 percent decline on Thursday [March 22]. New share issuance of this ETN was halted a month ago as investors scrambled into this and other volatility-linked securities to bet on an increase in more market gyrations down the road.

The decline started on Wednesday [March 21], when speculation began that Credit Suisse, the issuer, would reopen issuance of the ETN on a limited basis. Credit Suisse announced a few hours after Thursday's close of trading that it would resume issuing new shares.

The price decline is not a surprise — the ETN's price had diverged from its underlying net asset value as a result of the halt in share issuance, so the move could have been predicted.

But the swiftness of the move caught investors by surprise, and analysts had warned that this product — as well as others — are not designed for long-term holding.

"Buyers of TVIX were uninformed. There was no reason to buy TVIX when it was trading at such a premium... They were all caught off-guard when it started dropping in price later in the week," said TABB Group analyst Henry Chien.

More than 30 million shares in TVIX traded on Thursday and more than 27 million on Friday, making it about as active as liquid stocks like Citigroup and Microsoft.

"For end-users of volatility products in general, they should be careful and educate themselves on the mechanics of the product, because something like this could happen again," Mr. Chien said.

Investors had flocked to products that bet on or hedge against volatility in recent months on concerns that the market rally — which has continued nearly unabated since December — would not be sustained. However, some investors started to hold the products, intended for short-term hedges, for long periods, exposing themselves to losses due to the product's structure.

"I assure you that there are a lot of people who owned TVIX and lost a lot of money without understanding why," said Larry McMillan, president of McMillan Analysis Corp., in a report to clients issued Friday, referring to Thursday's action.

Whether the new shares were actually issued on Friday was unknown as Credit Suisse declined to comment. The company also declined to comment on what "limited basis" meant.

Credit Suisse stopped issuing shares in the product in February when investors, betting on volatility, started trading the fund more heavily. The halt caused the price of the fund to diverge from its net asset value, which would only correct after new shares were issued.

Volatility traders have been noticing big swings in TVIX all week. At the start of the week, the ETN, which aims to double the daily move in an index tracking short-term VIX futures, rallied about 7 percent when VIX futures were actually down about 3 percent due to what some traders called a short squeeze.

On average, on a daily basis, the TVIX moves about up and down in percentage terms as the VIX does and twice as quickly as front-month and second-month VIX futures.

The ETN gave back most of its premium to its indicative value on Thursday when it plunged in its heaviest day of trading since mid-February. It had been trading to a huge premium to its net asset value.

"The timing of the collapse of the Net Asset Value of the fund was certainly suspicious," said Chris McKhann, analyst at optionMonster.com.

Mr. McKhann noted the TVIX's price was 89 percent greater than the net asset value of the note on Wednesday, and that difference has since collapsed as investors scrambled to dump their holdings.

"Most of the people who owned the TVIX did not understand that it was trading at a huge premium to its NAV, let alone understanding the product itself. But this does not help to restore retail investors and traders faith in a fair market," Mr. McKhann said.

Volumes in the ETN surged in mid-February as investors increasingly turned to exchange-traded products as a way to bet on or hedge against volatility, especially in the prolonged complacency in the market.

"The price action in this ETN became purely speculative driven by no fundamental valuation whatsoever," said Scott Maidel, senior portfolio manager, equity derivatives at Russell Investments in Seattle.

Due to the carry cost associated with these types of volatility ETNs, they are typically used as trading instruments rather than buy-and-hold investments.

Carry costs occur when the VIX futures term structure is upward sloping — where the front month futures contract is priced at a lower cost than the back-month contract, which the ETN is buying. The price difference in these contracts has been rising, a greater cost for investors who thought they could buy and hold the note.

The rise in volume was a concern to Credit Suisse, which stopped issuing shares, citing "internal limits" for the size of the ETN. There were concerns that demand for the security would start to have an undue influence on the volatility futures market, rather than tracking those contracts.

The VIX, the CBOE Volatility Index, is the market's favored gauge of investor anxiety. It is not a traded index, but futures contracts trade on the CBOE and a handful of exchange-traded products track those futures contracts.

By Angela Moon and Doris Frankel

California Sounds Retreat in War on Arithmetic

Calpers is reducing its risk adjusted rate of return to 7.5%. Tell me where
you can get relatively risk free return of 7.5%? Equities? Govies? F500 Corp
Bonds? Aivars Lode


California is staging a limited retreat in the war on arithmetic—but it’s vowing to fight on.

Just like in New York, where the state legislature recently vetoed a plan to put the state’s wobbly pensions on stable footing, California is facing a crisis borne out by numbers. The problem bedeviling California is the gap between the money it has promised to pay retirees and the money it has—or expects to have—to pay the claims, estimated at about $500 billion late last year. For years, California politicians and union leaders rallied around a lie: They promised big benefits to employees while telling taxpayers that it wouldn’t cost a lot of money. They took less money out of current tax receipts than required to honor the pensions, and they assumed unrealistically high rates of return on the assets they did sock away. The wood fairies and the forest elves were going to make up any shortfalls.

The trouble with math, of course, is that it is so implacable. You can tell it anything you want; the numbers don’t change. If you don’t put enough money away, and it doesn’t grow as fast as you tell yourself it will grow, you won’t have enough money when the time comes to write the checks.

That is where California is today.

Despite the best efforts of public unions and government planners to deny the hard truth, in some combination, payouts will need to drop and other contributions will need to rise to keep the funds from running out of dough.

Calpers, the most important California retirement fund and one of the largest pension funds in the country, is responding to the crisis with a partial recognition of reality. For the first time in nearly a decade, it is lowering its estimates for return on investments to 7.5 percent.

This will be an extremely painful adjustment for a state where budgets are already strained to the breaking point. The Wall Street Journal reports that state workers will likely see layoffs and increases in their pension contributions. New pension obligations are expected to cost the state an additional $303 million per year, and many local governments face price increases of two to three percent.

Yet this may not even be the worst news for California. One Calpers actuary believed that the penion plan only had a 50 percent chance of achieving a 7.5 percent return and suggested that a more realistic number should be 7.25 percent, which would place it among the lowest in the country. The only reason these estimates weren’t lowered further were concerns at Calpers about the government’s ability to pay. Clearly, something is wrong, and as much as California employees would like to ignore it, the arithmetic doesn’t lie.

Wars on arithmetic never end well.

http://blogs.the-american-interest.com/wrm/2012/03/15/california-sounds-retreat-in-war-on-arithmetic/

Brussels approves transfer of UK Royal Mail pensions deficit

Pension funds globally are finding it difficult to get yield.  Venture Capital , Hedge and Private Equity funds have not delivered the results promised! Aivars Lode

UK – Proposals for the UK government to take on the Royal Mail's £4.6bn (€5.4bn) pension deficit have received sign-off from the European Commission, with the imminent transfer resulting in the creation of a new, smaller and fully funded pension scheme.

Approving the UK government's request to grant state aid, the Commission said it would only allow for the transfer of any costs in line by "comparable companies".

Article continues below

Joaquin Almunia, the commissioner responsible for competition policy, said it was important to ensure no market participant enjoyed an undue advantage.

"The relief of excessive pension costs and the restructuring aid approved today will help ensure this balance for Royal Mail and its competitors," he said.

Norman Lamb, minister for postal affairs within the UK Department for Business, Innovation and Skills (BIS), said the government "warmly welcomed" the approval of state aid.

"It safeguards the universal postal service by allowing the government to relieve, in full, the historic pension deficit of the Royal Mail Pension Plan and restructure the debt on the company's balance sheet as required at the time of sale," he said.

First announced as part of 2010's Postal Services Bill, the Department for Business, Innovation and Skills (BIS) at the time said the Royal Mail Pension Plan would shrink to around one-tenth of its current size.

Lamb said the new fund, the Royal Mail Statutory Pension Scheme, would be established using secondary legislation.

A BIS spokesman added it expected the new fund to be around £2.5bn, with the remaining £28bn in assets and liabilities transferred to the Treasury.

The proposed asset transfer would imply a noticeable increase in assets under management since September last year, when Royal Mail Group's half-yearly report noted assets of £28.1bn, with a deficit of £4.7bn.

At the time, chief executive Moya Greene said it was "essential" to receive permission from the European Commission on the restructuring, while critics have branded the transfer of assets to the Treasury "dangerous".

Author: Jonathan Williams

Regulation will deepen impact of inflation on pension funds – BlueCrest

Pension funds continue to balance their portfolios to identify yield. Aivars Lode

GLOBAL – New regulation, such as the introduction of Solvency II, will leave pension funds unable to cope with the eventual return of high inflation, BlueCrest Capital Management has warned.

Speaking at the Irish Association of Pension Funds investment conference in Dublin, fund manager George Cooper pointed out that steep inflation waves were usually linked to steep population growth.

Article continues below

He argued that the "very strong" commodities rise seen over the past decade had in fact not been matched by wage increases – leaving many national exchequers with diminishing tax returns.

He added that the new European Union fiscal stability pact – which the Irish electorate was set to ratify or reject in the coming months – was "most ridiculous" and a "European suicide pact".

He said Europe risked "Japanese-style deflation" and that the continent faced low inflation, returns and growth in the near term.

"Part of the solution to the governments' financial problems is that they have been implementing regulation to encourage pension funds to move their assets more and more into long-term nominal bonds to push their interest rates to support their economy," he said.

"The problem with that is, once inflation comes through – and I still think that is quite a way away – the real value of that debt will be almost completely eroded. Therefore, pension funds will be left with quite a huge shortfall in real terms from their investments.

"The real challenge for the pensions industry is to work out when it will be able to shift from this debt/deflation wave into this monetisation/stagflation wave."

Cooper said the "key" for this switch would be a shift in strategic asset allocation away from the long-term nominal bonds back to real assets such as real estate and equity.

He also argued that one way of addressing rising shortfalls in pension schemes was to introduce a "floating" retirement age – linked to longevity increases – although he conceded that this would not be a politically popular reform.

"We need to move towards a more flexible system and recognise that no pension fund is able to guarantee returns and pensioners have to […] share some of that risk," he said, adding that accounting changes should take account of "real" economic growth and uncertainty surrounding investment returns.

Cooper argued that, if such changes were made, then schemes would no longer be forced to de-risk through investment in long-term nominal bonds – while acknowledging that regulators had a "vested interest" in institutional investors increasing their sovereign debt holdings.

Author: Jonathan Williams

10 Leadership Lessons from the IBM Executive School

Is your fund stacked out with individuals that possess these characteristics? -Aivars Lode

In 1955 IBM’s legendary CEO, Tom Watson Jr., gave my mentor, Louis R. Mobley, a blank check and carte blanche to create The IBM Executive School. Fresh from successfully implementing IBM’s first supervisor and middle management training programs, Mobley confidently set about churning out executives as well.

The first thing he did, in conjunction with GE and DuPont, was hire the Educational Testing Service (ETS), the same company that still does the SATs, to identify the skills that make great leaders great. Once these intellectual skills were identified, Mobley and his colleagues at GE and DuPont assumed that spitting out executives would simply mean “training to the test.”

ETS dutifully rounded up a bunch of proven leaders and tested them every which way from Sunday looking for their common skills. The results were astounding and more than a little disturbing. As Mobley put it, “No matter what bell shaped curve we drew, successful leaders fell on the extreme edges. The only thing they seemed to have in common was having nothing in common. ETS was so frustrated that they offered us our money back.”

But failure wasn’t an option for Mobley, and after many a dark night of the soul he finally hit upon the answer. Unlike supervisors and middle managers, what successful executives shared were not skills and knowledge but values and attitudes. And over time Mobley identified the values and attitudes that great leaders share.

1) Great Leaders Thrive on Ambiguity. While most of us like black and white decisions, successful leaders are comfortable with what Mobley called, “shades of gray.” Great leaders are able to hold apparent contradictions in tension. They use the tension these paradoxes produce to come up with innovative ideas.

2)   Great Leaders Love Blank Sheets of Paper. Supervisors and middle managers use a framework of policies and procedures to guide them to the proper decision. They want a plan that reduces their job to filling in the blanks or what Mobley called “following the bouncing ball.” By contrast, leaders create the blanks that managers fill in. Like some business Einstein intent on reinventing the universe, every great leader relishes the opportunity to “think things through” from scratch.

3)   Great Leaders are Secure People. Successful executives thrive on differences of opinion. They surround themselves with the best people they can find: people strong enough to hold a contrary opinion and argue vociferously for it. Great leaders crave challenges, and this means hiring the most challenging people they can find with no regard for whether today’s challenger might be tomorrow’s rival.

4)   Great Leaders Want Options. Long before it became fashionable, Mobley was a huge proponent of diversity. However his definition meant a diversity of opinion rather than the kind we usually associate with political correctness. Mobley’s great leader constantly demands diverse options from his team, and uses these options to produce creative decisions.

5)   Great Leaders are Tough Enough to Face Facts. At heart Mobley was a spiritual man who valued the Truth for the Truth’s sake. Successful executives face facts, and this means being open to the truth even when it is not what we want to hear. One of the most successful executives I know offers cash rewards to anyone in his company who can prove him wrong. Great leaders have a nose for B.S and abhor it.

6)   Great Leaders Stick Their Necks Out. It is a natural human trait to fear being evaluated. We crave wiggle room so we can deflect blame and get off the hook when things go wrong. In business what is often passed off as a collaborative effort is actually just an attempt to avoid individual accountability. Great leaders want to be measured and evaluated. They continually look for ways to measure things that may seem immeasurable, and they cheerfully accept the blame when they are wrong or fail to deliver. The old adage that success has a 1000 fathers while failure is an orphan does not apply to great leadership.

7)   Great Leaders Believe in Themselves. While great leaders crave advice, options, and strong colleagues, they all share a profound belief in themselves and their judgment. Mobley described great leaders as “people stubbornly following their star who don’t know how to quit.” Holding this stubbornness in tension with a willingness to be wrong is perhaps the greatest trick that every great leader must perform.

8)   Great Leaders are Deep Thinkers. Managers get things done. Executives must decide on the things worth doing in the first place. Though very difficult to quantify, great leaders are deep thinkers. They constantly dive below surface “facts” searching for new ways to knit those facts together. Great leaders are generalists not specialists driven by an omnivorous curiosity. They know that the answers they are seeking will probably emerge from outside business and from disciplines that may seem utterly unrelated.

9)   Great Leaders are Ruthlessly Honest with Themselves. Self-knowledge is perhaps the most critical trait that all great leaders share. Leaders question assumptions and disrupt complacency by relentlessly asking the question: “What is the business of the business?” This exercise develops and refines the organization’s mission and purpose, and it is little more than the age old question “Who am I?” applied collectively. If you are not clear about the purpose of your own life how can you provide a sense of organizational purpose for others?

10) Great Leaders are Passionate. They may be loudly charismatic or quietly intense, but all great leaders care deeply about what they are doing and why they are doing it. Perhaps most importantly they care about people. Every business is a people business, and passionately caring about people whether they are employees, customers, vendors or stockholders is an essential leadership value.

Once Mobley compiled his list, he was faced with another even more difficult problem: How do you instill values and transform attitudes? He discovered that unlike supervisors and middle managers, executives shared another trait: They were constitutionally untrainable and reacted with hostility to any effort to “brainwash” them with “training.” Worse, Mobley discovered that values and attitudes are not only impervious to typical training techniques, but hectoring people to change often had the unintended consequence of hardening existing attitudes instead.

As the result some deep thinking of his own, Mobley eventually realized that what was needed was “a revolution in consciousness” rather than the kind of step by step curriculum that leads to a single “right answer.” Taking a leap of faith, he decided that the values and attitudes he was looking for could only be brought about as a side benefit or unintended consequence of what almost might be termed “spiritual work.” Rather than converging on a super set of skills, the IBM Executive School fostered the divergence that values uniqueness and individual authenticity.

The risk of failure was real, but if Mobley was going to produce people willing to stick out their necks he had to stick out his own first. He abandoned lectures and books in favor of games, simulations and other experiential techniques designed, not to “train,” but to “blow people’s minds.”

As for the personal accountability and measuring results, Mobley’s record speaks for itself. He ran the IBM Executive School from 1956-1966. It was his students that turned IBM into the fastest growing and most admired corporation in the world in the 1960s and 70s…

Goldman flap underscores fiduciary issue

That is why our fund is focused on transparency and clarity of investment and return. Aivars Lode

By Darla Mercado

March 18, 2012 6:01 am ET

When midlevel Goldman Sachs executive Greg Smith blasted his firm publicly last week for what he deems its rapacious behavior toward corporate and institutional clients, many retail advisers whose résumés include wirehouse stints nodded in recognition.

Goldman Sachs & Co.

His New York Times Op-Ed piece struck an emotional chord with many of them who recalled relentless sales pressure.

“During the last 30 days that I worked at a brokerage firm, I received 25 e-mails from my branch manager on why every one of my clients needed to have [some] new proprietary mutual fund,” said Bob Rall, a fee-only adviser at Rall Capital Management and a veteran of Prudential Securities Inc.

“Everything was about the YTB on the product — the yield to the broker — not the yield to the client,” he said.

WAKE-UP CALL

Russell G. Thornton, a vice president at Wealthcare Capital Management Inc. and a Merrill Lynch alumnus, agrees.

“Within the commission and sales environment of the wirehouse world, the general operating principle is: "How can I sell the most stuff to my clients?'” he said.

Although Mr. Smith's frame of reference reflects the institutional market, some advisers hope that his Op-Ed will be a wake-up call for clients, getting them to demand better quality of service they receive from advisers.

“One thing this ... will certainly do is make the idea of a client-first duty of care harder to ignore,” said Michael Branham, an adviser at Cornerstone Wealth Advisors Inc. and 2012 president-elect of the Financial Planning Association.

“Regardless of your legal obligation, it makes business sense to put the client's interests first,” he said. “Whether it's [The Goldman Sachs Group Inc.] or a small independent broker-dealer, that's what clients are really asking for.”

Some of the media coverage declared that advisers' true loyalties are to themselves and their firms, not their clients.

“A blazing resignation at Goldman Sachs shows us once again that financial advisers too often put their own interests first,” blared a sub-headline in an article posted last week on Time magazine's website.

Some advisers think that they are far enough from Wall Street so that the Op-Ed won't spur clients to question their commitment.

But others said that all the attention the Op-Ed generated only made a stronger case for highlighting the distinction between advice from a fiduciary and product information from a sales representative. If anything, it gives the public a hint of the battle brewing in Washington over from whom a fiduciary standard of care should be required.

CLIENT LOYALTY

“I think clients want to know that whoever is working with them has their interests at heart, and that there's more loyalty to the client than to the firm,” said Susan John, chairwoman of the National Association of Personal Financial Advisors.

“In the world of Greg Smith, the affected clients are institutional and presumed sophisticated — they should know and understand the rules of the game,” said William L. McCollum, a portfolio manager and chief compliance officer at Eagle Financial Management Services LLC.

“To the retail client, the revelation of conflicts of interest may come as a surprise: They have been misled to believe that their interests come first, when in most cases, there exists no fiduciary relationship,” he said.

“These firms and their representatives should not pretend to be something they are not,” Mr. McCollum said.

But other advisers think that the basic tenet of doing what is best for the client transcends business models. In other words, fee-only service arrangements aren't the only way to do right by the customer, because bad apples can turn up among those advisers, as well.

“The whole fiduciary thing has been blown out of proportion, and ultimately it boils down to trusting someone,” said Mr. Thornton, who describes his fee-only business model as “not better, but different” from his previous commission-based work.

“There were people I didn't like and didn't trust at Merrill, but I also know fee-only people who I don't truly trust or understand. Bernie Madoff should have been a fiduciary, and he was the worst.” Mr. Thornton said.

“If you do what's best for the client, you still make money — but that's long-term, as opposed to short-term,” said Rick Peterbok, chief executive of Interactive Financial Advisors, a dually registered firm. “If you do more to help the client, the rest will be OK.”