Robbing The Poor To Pay The Rich?

This is exactly what it is:

Last week, the American International Group reported a whopping $19.8 billion profit for its fourth quarter. It was a quite a feat for a company that was on its death bed just a little over three years ago, so sick that it needed a huge taxpayer bailout.

But if you dug into the numbers, it quickly became clear that $17.7 billion of that profit was pure fantasy — a tax benefit, er, gift, from the United States government. The company made only $1.6 billion during the quarter from actual operations. Yet A.I.G. not only received a tax benefit, it is unlikely to pay a cent of taxes this year, nor by some estimates, for at least a decade. 

The tax benefit is notable for more than simply its size. It is the result of a rule that the Treasury unilaterally bent for A.I.G. and several other hobbled companies in 2008 that has largely been overlooked.

This rule-twisting could deprive the government of tens of billions of dollars, assuming the firm remains profitable. The tax dodge — and let’s be honest, that’s what it is — also will most likely help goose the bonuses of A.I.G.’s employees, some of whom helped create many of the problems that led to its role in the financial crisis.

Volume 4 Issue 3: Intelligent Investing

Integrity Is Hard To Come By

Ever since I was exposed to the world of investing, I have come across many people who swear by the "secrets" of Suze Orman. Suze Orman is not so much an investment guru, but more of a "savings" coach. She comes up with a bunch of ways to help people achieve financial freedom through saving and not necessarily investing. But that is not why I am writing this issue.

In recent years, Suze Orman had been launching several products that she swears by. No, they are not tricks or gimmicks. Some of these products actually add value and are pretty nifty. I will not go into that as Felix Salmon has already done that.

Since then, Orman has built a name for herself. But with great power, comes great responsibility. Of late, it appears that Orman has been shirking some of that responsibility. Here is Felix Salmon again:

Lying about being ranked by Hulbert Financial Digest is, needless to say, neither ethical nor honest. Which means, on an unsympathetic reading of Suze Orman, that she’s lying too. 

When I spoke to Orman last week, she made it very clear that her relationship with Grimaldi’s newsletter was no different than her relationship with the Approved Card — she’s an owner of both of them, thinks that both of them are very good products, and is proud of them both. (The same goes for her FICO package, too.) 

Orman also told me twice that the newsletter was rated number one — she was adamant about that. And now it turns out that it isn’t. I spoke to Orman on Tuesday; maybe Zweig hadn’t contacted her with his questions yet at that point. But at best Orman is extremely incurious about the “fabulous” newsletter that she is so keen to hawk and defend. And at worst she’s happy lying about it being ranked highly by Hulbert. 

And that’s not the end of the Grimaldi/Orman sins, either.

To get the whole context, you really need to read the full article. But in short, it appears that the way Suze Orman has been peddling her products wreaks of heavy conflicts of interest. It is always difficult to be objective when one recommends one's own products as an "investment".

I have said this time and again about "Sell-side" investment advice. Here is what I wrote back in April 2011:

Raising a flag over a corporate governance issue points towards a sketchy deal but a day later, RHB Research realized that they did not find out the appropriate facts. After Perisai clarified the matter, RHB Research realized that they had made a mistake and published a counter report on the next day, 31 March 2011, and withdrew their previous report.

This clearly shows very careless and irresponsible research on RHB Research's end. They caused a sell-down on Perisai and many people lost money on it. This brings us back to the issue of integrity. So from now on, every time one reads a research report from RHB Research, one would start questioning the quality of its research. "Could it be as bad as the Perisai case?" 

Here is another of Buffett's infamous quotes: 

     "It takes 20 years to build a reputation and five minutes to ruin it" 

To conclude, I would just like to point out that writing research reports is not easy. A lot of care and thought has to be put into it to ensure that lies and irresponsible research is not thrown around as it could have adverse effects on people's lives. This is the level of care, responsibility and integrity that we hope to aspire to at the Mainstreeter.

Good and reliable investment advice is really hard to come by. I have also written about a blooper that was made by a careless CIO. You would think that being a CIO, he would have done better homework before bringing up misleading points during a public presentation.

That is why when anyone gives investment advice, take it with a bowl of salt. A pinch just isn't enough. At the end of the day, the goal is to do your own research. Who better to trust about your money than yourself? Who is going to take care of your money better than yourself? Listen to facts and evidence.

A good technique to practice when obtaining investment advice is the "5 Whys". Simply put, it is a method for asking questions to identify the root of cause-effect relationships. To approach any given "fact", one should ask "why" at least five times. This technique was the brainchild of Sakichi Toyoda, which was used as Toyota's scientific approach which brought Toyota to such great heights (which does not seem so high right now, but that is another story for another day).

Basically, any given investment advice that does not pass the "5 Whys" test is probably not worth listening to. So next time you think of making a quick buck off some coffee shop rumour, test it against the 5 Whys test. Ask yourself if the advice makes sense. I hope that this will help keep your money safer that some of the investment advice that Suze Orman has been peddling.

The Mootness of Rating Agencies - Part 2

Not too long ago, I wrote about rating agencies are incentivized by incentives. This means that the credit ratings assigned are correlated with the amount the rating agencies get paid. The higher the rating agencies get paid, the higher the rating they will assign to the borrower.

Here is more evidence of the destructiveness of rating agencies:

West Haven, Connecticut, which has closed four school buildings over the past two years and fired 14 teachers to help cut its budget deficit, is about to pay Moody’s Investors Service almost double what it cost six years ago for a credit rating. 

Joseph Mancini, finance director for the city of 55,000 near Yale University, says he has no choice other than to meet the demands of Moody’s after the municipality’s bonds were downgraded to Baa1 in January, three levels above junk, from A2. 

“The market’s going to punish us for the rating we’re at,” Mancini said in a telephone interview. “If we didn’t get it rated, we would be punished even more.”

Connecticut is about to pay  double what it paid six years ago. The compounded growth is approximately 12% per annum. And one wonders why US corporate profits are at record levels. Here is why the rating agencies can exploit the borrowers:

“It’s very hard to convince someone to stop using S&P and Moody’s ratings because they’re such a market norm,” James Gellert, chief executive officer of Rapid Ratings, which charges investors rather than issuers for its grades, said in a telephone interview. “If you don’t have one, people will wonder what’s wrong with you.”

...

“There are very few businesses that have the competitive position that Moody’s and Standard & Poor’s have,” Buffett said. Berkshire is an “unwilling customer” of Moody’s when it issues bonds, Buffett said. “We pay for ratings, which I don’t like.” 

Moody’s raised its standard fee this year on corporate bond offerings to 5 basis points, or 0.05 percentage point, of the amount being raised with a minimum of $73,000, from 4.65 basis points in 2010, according to Michael Meltz, a JPMorgan Chase & Co. analyst in New York. S&P asks for 4.95 basis points with an $80,000 minimum, up from 4.75 basis points and a $72,500 minimum last year. It would cost $497,500 to have both companies evaluate a $500 million debt sale. 

S&P and Moody’s haven’t lost business as a result of their increases, said Peter Appert, an analyst at Piper Jaffray & Co. in San Francisco. 

“Pricing has no bearing on whether somebody is going to issue debt or not,” Appert said in a telephone interview. The extra interest a borrower would have to pay on an unrated bond is a “whole lot more” than the cost of a rating, he said.

And here is why rating agencies are a giant extortion scheme:

“They are extorting the cities of this country,” Frank said in a telephone interview. “By the criteria they use for the private sector, every full faith and credit municipal bond should be AAA.” 

Bonds from cities and countries are rated “more harshly” than those of banks and corporations, according to the academic study, which was released in August by Jess Cornaggia of Indiana University, Kimberly J. Cornaggia of American University, and John E. Hund from Rice. There’s “virtually no chance” of default on bonds backed by the ability to tax, Frank said.

Source: Bloomberg

Volume 3 Issue 42: Intelligent Investing

Why Bill Gross Is Fat

The simple reason is because he ate 500 basis points:

…introspective mea culpas are perhaps cleansing but somewhat suspicious in nature. The purpose and even the author’s subjective assessment can always be legitimately questioned. But suspicions aside, let me begin by stating this: There is no “quit” in me or anyone else on the PIMCO premises. The early morning and even midnight hours have gone up, not down, to match the increasing complexity of the global financial markets. The competitive fire burns even hotter. I/ we respect our competition but we want to squash them each and every day. You the client have 100% of our attention as always, as do your portfolios…So where do we go from here? Our internal growth forecast for developed economies is now 0% over the coming several quarters and the portfolio more accurately reflects this posture. Yet even so, can the golden glove regain its magic? Well, as I’ve indicated,we’re showing up early every day at the ballpark – in this case for a little fielding practice.

For someone who takes millions in salary, I would expect nothing less of him. But that's what world class really means. Some of you may talk trash about his poor performance this year (below the benchmark), but he is still managing the largest bond fund in the world. This shows that he is still world class.

And he is right. The global financial markets are getting more and more complex. The financial crises is going to wait for no one. As analysts (we are all analysts, in on way or another, as long as we try to think about this), we can't wait "until we are free" to begin analyzing what's going on. This means we have to make sacrifices.

In the case of Bill Gross, he even has to sacrifice is health. It may or may not be worth it, depending on which school of thought you are coming from. But I think I can relate to that a little bit. Of course I am far from being world class, but I can certainly relate to the "fatness" part because of the amount of hours I put in.

Volume 3 Issue 35: Intelligent Investing

The Fake News of HP M&A

This is what happens when you listen to tips and rumors. You lose your pants, and more.

Volume 3 Issue 22: Two-Cent Economics

Malaysian Alcoholics?

According to this lousy newspaper, Malaysia is the world's 10th largest consumer of alcohol. Intuitively, any Malaysian with half a brain would know that can't be true. I quote the highly inconsistent and poor newspaper:

Malaysia has been named by the World Health Organisation (WHO) as the world’s 10th largest consumer of alcohol despite its small population and size.

Statistics by the international body this year also showed that Malaysians spent over US$500mil (RM1.5bil) on alcohol with a per capita consumption of seven liters.

Beer consumption in Malaysia is 11 liters per capita.

Did any of you just did a double take? Surely you must have read it wrong. Perhaps you are drunk? If Malaysia's per capita consumption of ALCOHOL is SEVEN litres, how can BEER consumption per capita be MORE THAN SEVEN litres? Like I said, anyone with half a brain would have realized that something must have been amiss. Last I checked, beer was still alcohol. Perhaps they included the statistics for Ginger Beer and Root Beer?

So, I dug further and went to look for the WHO report which is entitled "Global Status Report on Alcohol and Health" (pdf file). Guess what I found? Here:

Alcohol consumption in liters per capita (2005)

Yes, I cut out a portion of the data. For those of you who doubt the integrity of the data, click on the pdf link above and go to page 61 of the pdf file. In the quoted WHO report, which has up to 2005 figures only, we see CLEARLY that Malaysia's alcohol consumption per capita is at a paltry 0.82 liters. So where did the seven or eleven liters come from? Whoever this Christina Tan is that is reporting for the Star should probably be sacked.

Better still, just stop subscribing to the Star. I have time and again found unreliable news in the Star and it is getting very frustrating. Reading the Star is probably no better than reading a Women's magazine: toilet reading at best.

Volume 3 Issue 15: Intelligent Investing

Why Do We Have to Be Careful?

About two weeks ago, I was attending this panel discussion organized by Bank Negara. One of the panellists was from Manulife Asset Management.

One of the remarks that he made was particularly shocking. While referring to Japan as a major trading partner of Malaysia, he casually brought up that it must be because of all the Toyotas that we import. This couldn't be more wrong and irresponsible.

Why is this so bad? First of all, he was right. Japan is the largest country of origin for all of Malaysia's imports in 2010, with a grand total of RM66.5 billion exported to Malaysia. However, what is grossly wrong about his statement was that most of the Toyotas are assembled in Malaysia. What's worse, if you look at the total value of cars imported by Malaysia (CKD and CBU cars), it is only around RM4.6 billion. Bear in mind, this is the total amount of cars imported to Malaysia. Assuming that even if 70% of this comes from Japan, the total car imports would only constitute about 4.8% of the total imports from Japan - see chart 1. Now you see why that information is so misleading.

Chart 1: Import Composition from Japan in 2010

And this information comes from the CIO no less. While at that point, it may not have hurt anyone, but as a responsible and seemingly influential figure (I assume he is influential, considering he was invited as a panellist),  he must provide accurate information at all times. Perhaps today it's this, but tomorrow, what if he gives out information that costs many people a lot of money.

Good information is so hard to come by these days.

Volume 3 Issue 13: Intelligent Investing

Integrity in Research

Here are 2 completely unrelated issues about investment research and why it is important to maintain integrity at all times. The first story is about the recent resignation of David Sokol of Berkshire Hathaway, touted to be one of the possible successors of Warren Buffett at the company.

Apparently, minus all the details of the deal that transpired, David Sokol had purchased 90,000 shares of Lubrizol several weeks before Berkshire acquired the company. It was made known that Sokol was the one who proposed the deal to Buffett. Although Buffett rejected the deal initially, he finally decided to listen to Sokol for whatever reasons. Now, post-acquisition, Sokol's investments saw a gain of 29% or USD3 million.

With the legality of his actions still in debate, there is really no point speculating on what is right and what is wrong. The point that I am trying to make is that Berkshire's squeaky clean image that was built up over the past 50 years or so is now tarnished, or at best, clouded.

As Warren Buffett wisely pointed out:

"We can afford to lose money - even a lot of money. But we can't afford to lose reputation - even a shred of reputation."

Imagine if David Sokol was proven to be guilty of acting on material non-public information. From then onwards, every deal that Berkshire makes, many would ask, "Does this deal serve the interests of one of Berkshire's executives?" This kind of publicity could spell the end of some businesses.

For further reading, click here. For a more detailed write-up from the Wall Street Journal, click here.

The second story is much closer to home.

This is about RHB Research Institute's report on Perisai Petroleum Teknologi Bhd. On 30 March 2011, RHB Research released a report which questioned the integrity of one of its acquisitions. This caused a major sell-down on Perisai and pretty much forced the Securities Commission to launch an inquiry on Perisai.

One of the quotes in the article was:

"Moreover, we believe there is a corporate governance issue relating to the effective purchase of the asset at 14x premium to the original disposal price of the same asset"

Raising a flag over a corporate governance issue points towards a sketchy deal but a day later, RHB Research realized that they did not find out the appropriate facts. After Perisai clarified the matter, RHB Research realized that they had made a mistake and published a counter report on the next day, 31 March 2011, and withdrew their previous report.
 

This clearly shows very careless and irresponsible research on RHB Research's end. They caused a sell-down on Perisai and many people lost money on it. This brings us back to the issue of integrity. So from now on, every time one reads a research report from RHB Research, one would start questioning the quality of its research. "Could it be as bad as the Perisai case?"

Here is another of Buffett's infamous quotes:

"It takes 20 years to build a reputation and five minutes to ruin it"

To conclude, I would just like to point out that writing research reports is not easy. A lot of care and thought has to be put into it to ensure that lies and irresponsible research is not thrown around as it could have adverse effects on people's lives. This is the level of care, responsibility and integrity that we hope to aspire to at the Mainstreeter.