Saturday, May 17, 2008 1 comments ++[ CLICK TO COMMENT ]++

Random Articles for the Week; Plus Some Investment Thoughts

Here are some items that I find interesting, along with some thoughts running through my head:


  1. Jean-Marie Eveillard First Eagle Conference Call
  2. The Economist article on the financial crisis: Paradise Lost
  3. Would you average down into this stock?
  4. Junk bonds vs Stocks - still trying to figure out when junk bonds are better



Jean-Marie Eveillard Conference Call

Thanks to Fat Pitch Financials for referring me to the First Eagle conference call for their mutual fund owners (audio link on their site doesn't seem to work me but here is the text transcript). I never heard of Jean-Marie Eveillard until a couple of years ago (goes to show how much of a newbie I am) but I have started to like him a lot more than other commonly referenced superinvestors. He is a value investor with a different perspective on many things. He also tends to be more international than many others.

I recommend reading the conference call transcript if you are a newbie to investing, if you want some international ideas, or if you are looking at investing in Japan. If you have read some of my past posts on him or if you have heard some of his interviews on Bloomberg or something, there isn't anything new per se. It's a good, quick, read. Here is an excerpt to whet your appetite:

John Arnhold: “You’ve mentioned that First Eagle’s value style is a combination of Graham and Buffett. Can you provide an example of a new position that you would consider a Graham-type company and an example of a Buffett-type company?”

Jean-Marie Eveillard: Today, the Ben Graham-type companies, in other words, the deep value stocks, are not available, really, in the U.S. or in Europe. They’re only available in Japan. And then, the great majority of those deep value stocks are small stocks. In view of the size of our funds today, as you know, we are looking more so into buying medium caps or large caps. At the same time, we have been doing some work and we already own a few, have owned sometimes for years, a few small deep value stocks in Japan and we’re in the process of doing some additional work on more.

I mean there are stocks in Japan where net cash, cash and sometimes portfolio securities, net of all financial liabilities, net cash is in excess of market cap, which means that you pay less than nothing for the business. Now, as Marty Whitman likes to say, “There is always something that can go wrong.” In that case, if the company were to suffer a string of losses for the next five years, then of course five years from now the cash would have disappeared as a result of the losses.

In terms of a Buffett-type company, at the beginning of this year, we started looking at what had been then and what remains an extremely depressed sector, of course, is the financial sector. We were not interested in the banks and the brokerage firms which remain “black boxes” and also there are still major issues with them. But, we figured out that the financial sector was not homogeneous and that beyond the banks and the brokerage firms, you also had the insurance companies and money management firms and situations a little bit unique like American Express.



If you are a Benjamin Graham fan, Japan is a paradise for you. Half the companies in Japan are trading below book value. Not only that, as Jim Grant alluded to, you have world-class companies trading below book. My impression is that even when American companies were depressed and in a similar state back in the 1940's, they were nowhere near as good as the some of these Japanese companies. Unfortunately, most of these are small-caps and language is a barrier (hard to find English information). In addition, Japanese companies are not shareholder-friendly and unlocking the value could be harder than trying to convince George Bush there are no weapons of mass destruction in Iraq ;)


Paradise Lost?

This week's The Economist, titled Barbarians at the Vault, deals with the credit crisis engulfing the financial institutions. If you are a professional in the field, you might want to pick up the magazine since there are quite a few articles on the topic (all are available online as well). Paradise Lost is an excellent article detailing what happened and how things got totally out of control. If you haven't been following the financial sector closely, you might want to read the linked article. It'll bring you up to speed on how capitalism in America almost had a heart attack...maybe it did.


If the crisis were simply about the creditworthiness of underlying assets, that question would be simpler to answer. The problem has been as much about confidence as about money. Modern financial systems contain a mass of amplifiers that multiply the impact of both losses and gains, creating huge uncertainty...

One [amplifier] is the use of derivatives to create exposures to assets without actually having to own them. For example, those infamous collateralised debt obligations (CDOs) contained synthetic exposures to subprime-asset-backed securities worth a whopping $75 billion. The value of loans being written does not set a ceiling on the amount of losses they can generate. The boss of one big investment bank says he would like to see much more certainty around the clearing and settlement of credit-default swaps, a market with an insanely large notional value of $62 trillion: “The number of outstanding claims greatly exceeds the number of bonds. It's very murky at the moment.”

A second amplifier is the application of fair-value accounting, which requires many institutions to mark the value of assets to current market prices. That price can overshoot both on the way up and on the way down, particularly when buyers are thin on the ground and sellers are distressed. When downward price movements can themselves trigger the need to unwind investments, further depressing prices, they soon become self-reinforcing.

A third amplifier is counterparty risk, the effect of one institution getting into trouble on those it deals with. The decision by the Fed to offer emergency liquidity to Bear Stearns and to facilitate its acquisition by JPMorgan Chase had less to do with the size of Bear's balance-sheet than with its central role in markets for credit-default and interest-rate swaps...

The biggest amplifier of all, though, is excessive leverage. According to Koos Timmermans, the chief risk officer at ING, a big Dutch institution, three types of leverage helped propel the boom and have now accentuated the bust. First, many banks and other financial institutions loaded up on debt in order to increase their returns on equity when asset prices were rising (see chart 1)...Second, financial institutions were exposed to product leverage via complex instruments, such as CDOs, which needed only a slight deterioration in the value of underlying assets for losses to escalate rapidly. And third, they overindulged in liquidity leverage, using structured investment vehicles (SIVs) or relying too much on wholesale markets to exploit the difference between borrowing cheap short-term money and investing in higher-yielding long-term assets.


Anyone thinking of investing any of the financials need to keep the following chart in mind:

(source: The Economist)



The Wall Street banks are heavily leveraged! If you are thinking of investing in them, you need to seperate out these highly leveraged banks from the conventional lowly-leveraged bank you find on your street corner. Similarly, not that many would contemplate investing in these super-high-risk creatures, but monoline insuers also have something resembling massive leverage (since they are insurance companies they are kind of different but, nevertheless, small changes in expected losses on their insurance policies can wipe out the company). On a side note, although the leverage seems to have increased recently for some of the financials, it is not necessarily because they took on more risk; instead, it is likely because their shareholder's equity is getting wiped out and hence the leverage ratio increases.

Would You Invest in This?

Would You Invest in This? Is this going bankrupt?

(source: Yahoo! Finance)



Too bad that's a stock that I actually own--a big chunk of my portfolio as well :( This ugly-looking chart is for, none other than, Ambac. Did I catch a falling knife? I'm still not sure if I should average down into this. I don't have enough money and I would still like to diversify my portfolio more by investing in a retailer or a Japanese stock so I won't do anything for the time being. I think if Martin Whitman or Legg Mason (not sure if it's Bill Miller or someone else on his team) didn't have a positive view on the monolines, I probably would consider this a mistake and not think about averaging down.

Junk Bonds vs Stocks

One idea that I have been researching lately is junk bonds. It's still not clear to me what is a good yield for the bond. This isn't a big idea for me (in the end I might do nothing) but it's something that I'm investigating. Bonds are poor investments in taxable accounts, not to mention the fact that stocks can beat them easily due to compounding of reinvested earnings, so it isn't something I would use as a primary holding. I am primarily looking at it strategically as a contrarian opportunity.

I have been looking at how Warren Buffett, Martin Whitman, Jean-Marie Eveillard, Mohnish Pabri, among others, have invested in junk bonds. Junk bonds were very attractive back around 2002 and many of these investors invested in them. Eveillard, Pabri, and Buffett bought Level 3 Communications. Buffett bought Amazon and Nextel bonds at that time as well. Martin Whitman has always been a big buyer of junk bonds given that he is a distressed investing specilist (in the early 2000's, he bought K-mart bonds).

Of course, high yield spreads were higher in 2002 so junk bonds are not as appealing now. If we look at some select recent junk bond purchases, we see Buffett buying TXU with around 12% yield (I am trying to find out the maturity on these bonds and if anyone has any idea leave a comment). Given Buffett's insider knowledge of TXU, he probably treats this as a super-low-risk almost-cash holding. Some of Martin Whitman's latest investments have been the MBIA surplus notes (around 15% yield) and Standard Pacific (around 20% yield). Whitman considers MBIA surplus notes as almost-cash with low risk (but potentially illiquid). I'm wondering if a bond with around 13% to 15% yield is worth it?

The bond that I'm looking at (assuming it still pays interest) is the Sears Roebuck Accept Corp 7% Note 07/15/2042. It was delisted and is trading on the Pink Sheets OTC grey market under the ticker symbol SBCKP. It is thinly traded and has a yield of around 13% to 15%. I'm wondering if this is worth it; or whether Sears Holdings stock is better. The problem I have with this (assuming I can buy it for a reasonable price) is its long maturity. I think if it were due in the 2020's, I would be ok with it (inflation risk is a big concern for such a long-dated bond).

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1 Response to Random Articles for the Week; Plus Some Investment Thoughts

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