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Crisis or Opportunity? My take on the Bear Stearns buyout

Posted on March 17, 2008
Filed Under Business, Investing | 1 Comment

Wow. Who would have thought a year ago that Bear Stearns would simply crumble like it did? The stock was around $140, things were looking good and, bam, the mortgage crisis hits and Bear Stearns stock enters into a tailspin that “ended” today at $4.10 per share (a couple bucks above the proposed buyout price of $2 which could mean shareholders are optimistic that the deal price will edge up in the coming days and weeks).

As a long time student of the financial markets (and not an owner of Bear Stearns stock) today was one of those days that gets me excited. Will there be a massive sell off? Further loss of wealth? Or will people be rational about things and take this situation for what it is, a “trimming of the fat” if you will?

With all the sensational media coverage early this morning I feared the worst. I figured investors would send the market into a downward spiral. Investors have overreacted in the past so why would today be any different? Then, Maria Bartoromo appeared on the TV and, lo and behold, was pretty rational about the situation.

Maria spoke about this situation being a good thing for markets long terms and suggested this was not a huge crisis of epic proportions and in fact a good thing. I almost fell off my couch not because Maria is usually sensationalist (she is usually level headed actually) but because she was the only media person not talking about doomsday. It was then that I had hope that this time things would be different.

As the day unfolded there was, as to be expected, a run to the big blue chip stocks sending the Dow up 21 points for the day (partly due to JP Morgan’s stock rising about 10% due to the deal). Holy smoke! It was up! Of course the S&P and the NASDAQ ended down but not by too much. They were only down 0.90% and 1.60% respectively at the close of trading and some companies in various sectors had OK to good days in both of those indices.

It seems that investors acted fairly reasonably today and recognized this situation for what it was: a consolidation that needed to happen in order to maintain stability and to allow things to push forward.

If anything today was a day to consider buying solid companies (which a lot of folks did) since a lot of them would be selling at a discount due only to the Bear Stearns sale and not to anything they could control. Today was a day for the smart value investors to step up and shine.

What a fascinating day. The mob could have ripped the markets to shreds but they didn’t. Well, I guess there is always tomorrow but for now I am impressed with how things turned out. Are investors getting smarter and more rational? Who knows but if today is any indication I think we’re heading in the right direction in terms of mindset.

Marketocracy: Behind the Numbers

Posted on February 21, 2007
Filed Under Investing | 2 Comments

MarketocracyMutual Funds - We all use them and a lot of us rely on them for the bulk of our retirement savings but the percentage of us that know a lot about them is very small. In a prior life I worked in the mutual fund business and I thought that I would someday be a mutual fund manager before the entrepreneurial bug bit so I know a little bit about how the funds and the business of funds work. Needless to say I was very intrigued when I saw a piece on VentureBeat the other day about a newish fund/asset management group called Marketocracy.

The idea is a fairly simple one and one that has been tried before. Ken Kam, who co-managed the Firsthand Technology Value Fund in the bubble days (which was rated the no. 1 fund by Lipper - the defacto fund rating firm - for five years no less), thought that getting a lot of top minds (80,000 or so) together was the best way to pick a portfolio. Marketocracy was the vehicle for this. It allowed anyone to sign up on the web and manage a fund with a virtual $1mm. The best managers would then rise to the top and give Ken the ideas he needed for the Marketocracy Masters 100 fund (MOFQX).

The masters 100 fund has gone on to return 71% since inception (Nov 2001) which is a pretty good return. Now Marketocracy is even branching out into the managed accounts business ($10k minimum investment) where Ken will blend the four masters he just chose (i.e. best earning portfolios at marketocracy out of the 80,000) to achieve top returns for investors. Not bad, eh? I mean, who doesn’t want to earn 71% over 5 years in a mutual fund and possibly even more with the managed account? Answer: you.

Now, don’t get me wrong, I’m not saying that you shouldn’t want to make 71%. What I am saying is that it is not a great return relative to other similar funds. Not convinced? Let me prove it.

I’ve got the hook-up in the mutual funds biz so I had some Morningstar reports pulled on the Marketocracy masters 100 fund. What I was able to find was pretty surprising. The 71% return was correct and totally legitimate so that wasn’t the issue. The issue was with the beta and alpha of the portfolio (see Morningstar chart below).

The beta and alpha of the masters 100 fund relative to the S&P 500 are 1.69 and -6.28. The S&P has a beta of 1.0 so the fund is riskier than the S&P. Big deal - no risk, no reward right? Definitely. That’s where alpha comes in.

Alpha measures the relative risk of the fund as compared to the market (S&P 500 in this case). A negative alpha means that the fund did not achieve returns large enough to justify the risk taken. As you can see, the alpha of the masters 100 fund is pretty darn low meaning that the risk was far too high for the returns achieved. Basically, if you were invested in the masters 100 fund you took a lot of extra risk that you weren’t compensated for.

Ah, but what about the best fit index to the right, the Russell 2000 Growth? Good point. So, what Morningstar is saying is that the Russell 2000 Growth index is better aligned with the investment profile of the masters 100 fund. As you can see the numbers don’t look as bad. The beta is less than one so the masters 100 fund was less risky than the Russell 2000 Growth. However, the alpha is -1.41 meaning that the returns were still too low for the risk taken.

Now, I know the fund still made 71% so it wasn’t a bad place to be. However, there were similar funds to the masters 100 fund that did far better over the past five years. For example, there is a Fidelity fund in the same category as the masters 100 fund that did very well over the same period. How well? Check out the data below.

Holy cannoli! The Fidelity fund returned 246% in the same time frame that the masters 100 fund returned 71%. That’s a huge difference which is even more apparent when you check out the annualized returns also listed in the above graphic.

So, the moral of the story is to always dig. Sure, I would have been happy with a 71% return. However, I would have taken more risk than I needed to in order to achieve that return and there were some better options out there in the same category as the masters 100 fund.

In the end of the day the masters 100 fund has only proven to be an average performer so far. But, as the mutual fund lawyers say, past performance is no guarantee of future results (i.e. investors beware). Ken Kam is definitely a bright guy and a really good fund manager but he hasn’t leveraged the full power of the wisdom of the Marketocracy crowds just yet. I still think the idea has some merit (if you’ve got 80,000 virtual portfolios there are bound to be some great ones in there) and that it just needs to be executed well. Let’s see if Ken can make this idea pay for him, the investors in the marketocracy products and his investors (yup, he’s got some VC - $16mm to be exact - from US Venture Partners, Formative Venture Partners and some individuals).

Side note: Please don’t take this as official financial advice and get upset when things don’t pan out down the road.  Again, investor beware.