Monthly Archives: January 2008

Should I hire a financial adviser?

A question from Askville:

I met with an “Ameriprise” financial adviser and am thinking of hiring him. It’s not that expensive and I defiantly am not great managing my finances but I’m wondering if it’s overkill for me. I make a low six figure income, have a little credit card debt, a 401k, stock options, and I own a home. To date this hasn’t really been very complex but I’m not sure if I’m making the right decisions for the long term. Any advice about the benefits of a financial adviser would be greatly appreciated.

There are three kinds of advisers, fee-only, commission-only, and fee-and-commission.  Fee-only advisers are paid only by their clients such as yourself.  Commission-only advisers earn commissions on sales of insurance policies, mutual funds, annuities, and other products they sell.  Fee-and-commission advisers attempt to earn both ways.  It’s easy to see that an adviser earning commissions would be sorely tempted to push products that pay higher commissions, regardless of how appropriate they are for a particular client.  In fact, many products sold by commissioned advisers are downright overpriced (with a good chunk of that overpricing going straight to the adviser).  So in my opinion, you should stay clear of commission-only and fee-and-commission advisers; even if they resist the lure of higher commissions on bad products today, there is no guarantee they would continue to do so in the future.

In your situation, I would say that you need a financial planner more than a full-service adviser.  You would meet with the planner initially and discuss your financial situation (income, expenses, family situation, retirement expectations, etc.)  Based on that situation, the planner would draw up a written long-term financial plan, including strategic asset allocation (how much money you should commit to stocks vs. bonds over the long haul), tactical asset allocation (how much money you should commit to stocks vs. bonds over the next year or so), and recommendations on changes to be made to your existing portfolio.  From then on, you would meet with the planner about once a year, review your progress, and adjust your financial plan if necessary.  Depending on where you live and how complex your financial situation is, the initial consultation (including preparation of your financial plan) may cost you anywhere between a few hundred and a few thousand dollars, an annual update, significantly less…

SPACs to become mainstream?

From Institutional Investor:

DONE DEALS
A Book Full of Blank Checks

17 Jan 2008
Dan Freed

Inspired by the backdoor IPO of hedge fund firm GLG Partners, advisory boutiques are flocking to a type of transaction once reserved for boiler-room manipulators.

When GLG Partners co-founder Noam Gottesman told investment bankers Joseph Perella and Peter Weinberg last spring that he wanted advice on selling a stake in his hedge fund firm to Freedom Acquisition Holdings, a special-purpose acquisition corporation, the bankers were a bit puzzled. London-based GLG was a giant in the hedge fund business, and SPACs — essentially, shells that go public to raise capital and buy operating companies — historically had been a financing device favored by shady operators. But Perella Weinberg Partners took the assignment anyway. The deal, a reverse merger that gave Freedom a 28 percent stake in GLG and valued the asset manager at $3.4 billion, was announced in late June.

Since that deal closed November 2 and GLG became a public company, the initial investors in Freedom have doubled their money. And Perella Weinberg is among several boutique investment banks that have developed a taste for launching SPACs. The firm is a minority owner of BPW Acquisition Corp., a SPAC that in November registered with the Securities and Exchange Commission for a $375 million IPO. The majority owner is Brooklyn NY Holdings, the investment vehicle of the Lerner family, which sold credit card giant MBNA Corp. to Bank of America Corp. last year and owns the Cleveland Browns football team. According to its prospectus, BPW Acquisition aims to buy a financial services company, relying on the expertise and advice of the Lerners and Perella, who is a vice chairman and director of the SPAC. The company’s CEO is Michael Martin, the former head of financial institutions investment banking at UBS who now runs Brooklyn NY Holdings.

Other advisory firms that say they are launching or considering SPACs include Centerview Partners, Greenhill & Co., Lazard and Peter J. Solomon Co. Lazard is sponsoring Sapphire Industrials Corp., which has filed for a $800 million IPO and will seek to acquire an industrial company; Greenhill is backing GHL Acquisition Corp., a SPAC that has registered for a $400 million debut offering. These moves could allow advisory firms, which lack stock-underwriting capabilities, to help clients that want to raise public equity capital. The SPAC structure is attractive to IPO candidates such as GLG that want to avoid the red tape of a conventional offering, including filing prospectuses and holding investor road shows. SPAC sponsors go through that process, not the companies they buy.

“Freedom sort of proved that you could buy a world-class asset using the SPAC structure,” says Nicolas Berggruen, one of Freedom’s founders. “And it was a much more efficient way to bring a company public than the normal IPO process.”

The burst of deals is part of a broader SPAC boom. Through December 12, SPACs accounted for nearly one of every four U.S. IPOs in 2007, up from 16 percent in 2006 and 5 percent in 2004, according to Dealogic. From October 1 through December 12, SPACs raised $6.14 billion, more than in the three previous quarters combined.

But the wave of boutique-sponsored SPACs also raises questions about potential conflicts of interest. For instance, how would a firm handle selling a client company to a SPAC it partly owns? As a representative of the seller, the firm would be obliged to seek the highest possible price. But as a shareholder of the acquirer, it would want to pay as little as possible. Officials at Perella Weinberg and BPW won’t comment on the issue. BPW’s prospectus says that it expects to source targets “from various unaffiliated sources within the financial community.” But it also notes that BPW management may bring companies to the SPAC’s attention.

The SEC isn’t too concerned about the surge in backdoor IPOs. “SPACs include a great deal of disclosure about how they will seek acquisitions, how they will evaluate potential acquisitions, and what information they will provide shareholders for them to evaluate any proposed acquisitions,” an SEC spokesman says. “Most seek shareholder approval and offer them the opportunity to get their money back instead of holding an interest in the combined entity.”

The lunar economy?

A question from Yahoo! Answers:

When man finally colonized the moon, and find water, oil and natural minerals there, do you think this can created an economy there and many other people will go there to establish themselves, just like the Americas in the past?

Mass colonization of the Americas has not happened until affordable intercontinental transportation was developed. Similarly, mass colonization of the Moon will not happen until we have affordable interplanetary transportation.

However, you seem to make a very important mistake in your reasoning; you assume that an economy can only exist because of natural resources. In reality, the economy exists only because of people; in the average developed economy of today, 70% of what is produced and consumed is services, and the percentage will go further up in the future. Get together enough people, and there will be an economy…

What is a hedge fund?

A question from Askville:

Can anyone explain to me, in layperson’s terms, what a hedge fund is?

“Hedge fund” is more of a legal term than anything else.

The first hedge fund was created by A.W. Jones in 1949 and had a strategy that today would be termed “equity market-neutral”; the fund bought stocks it expected to outperform and shorted stocks it expected to underperform. In other words, the fund hedged away its market risk (hence, the term “hedge fund”). The fund was structured as a limited partnership, was available only to accredited investors (high net worth individuals and institutions), and was compensated strictly through performance fees (20% of total return delivered to investors).

Over time, other funds developed other strategies (many of which actually do not involve any hedging), but the name stuck. Additionally, many funds started to charge a base fee (1% of assets under management, although lately 1.5% seems the norm and 2% is not unheard of) in addition to performance fees. In addition to the traditional limited partnership structure, there are also funds structured as offshore (Bermuda, Caymans, Luxembourg, Channel Islands, etc.) corporations, which cater to non-U.S. investors and tax-free U.S. investors, such as pension plans and university endowments.

So, to summarize, a hedge fund is a limited partnership (or an offshore corporation) that is available only to accredited investors, whose manager derives at least a part of its compensation from performance fees. The term does not imply any particular investment strategy.

Here are some of the common strategies used by hedge funds:

  • Convertible Arbitrage funds buy convertible bonds and short their underlying stocks.
  • Dedicated Short Bias funds specialize in shorting stocks.
  • Emerging Markets funds invest in government bonds of emerging-market countries (Argentina, Brazil, China, India, Russia, etc.), as well as stocks and bonds of companies from those countries.
  • Equity Market Neutral funds buy stocks they expect to outperform and short stocks they expect to underperform, in approximately equal quantities.
  • Event Driven funds come in two flavors. Distressed funds buy securities of the companies that are in bankruptcy or near it, but are expected to recover. Risk Arbitrage funds play the merger game; they buy stocks of companies that are being acquired while shorting the stocks of companies that try to acquire other companies.
  • Fixed Income Arbitrage funds attempt to profit from relative mispricing of closely related fixed-income securities (for example, a 13-week U.S. Treasury bill and a 5-year Treasury bond maturing in 13 weeks) by buying the relatively cheap one and shorting the relatively expensive one.
  • Global Macro funds attempt to profit from country- and region-wide trends in stock, bond, and currency markets.
  • Long/Short Equity funds are similar to equity market neutral funds, but they do not necessarily maintain market neutrality; at any given time, a long/short fund may be net long, net short, or neutral.
  • Managed Futures funds speculate in futures contracts on commodities, currencies, interest rates, and stock market indexes.

There are also multi-strategy funds that invest in many strategies simultaneously, and funds of funds that only invest in other hedge funds.

* * * * *

March 20, 2008: A related question from Askville:

What exactly are hedge funds supposed to do? How do they differ from mutual funds?

The differences between hedge funds and mutual funds are very simple to explain.  As I said above, a hedge fund is a limited partnership (or an offshore corporation) that is available only to accredited investors, whose manager derives at least a part of its compensation from performance fees.  A mutual fund, conversely, is a special purpose entity (tax lawyers would call it a “pass-through entity”) that is available to the general public, whose manager generally receives no performance fees (the SEC frowns upon performance fees, and it has good reasons to do so).

Paul Krugman on employment and confidence

Paul Krugman writes:

I’ve been using the employment-population ratio rather than the unemployment rate as an indicator of labor market conditions; the unemployment rate has been fairly low, roughly late-90s levels, but employment-population has never regained its late-90s peak.

But which measure corresponds most closely to how people feel about the economy? A plot of e-p ratio (red, right scale) versus the percentage of Americans saying that the economy is good or excellent (blue, left scale) (June and December data only):

Employment and confidence

The EP ratio seems to track public sentiment pretty well. Going by the unemployment rate, people should have felt as good about the economy in 2007 as they did in 1998-1999. Some people blame the liberal media; I think people were reacting to the reality of the situation.

Mortgages, car loans, and write-offs

A question from Askville:

With all the repos in the housing area, why aren’t car loans and leases showing up as writeoffs?

Because cars were not financed at inflated values…

Let’s say lender financed a house appraised at $300,000 with a 100% loan-to-value loan (i.e., the face value of the loan was $300,000).  The borrower paid off some of the principal (let’s say, the outstanding principal now is $280,000) and then defaulted.  The lender repossessed the house; then it looked around and realized that the house can be sold, at best, for $250,000, and there are fees to be paid in order to sell it.  And if the house is to sell quickly, the price must be dropped further.

The problem, as you can see, is that the value of the collateral dropped below the loan value.  Normally, banks would cap loan-to-value at 80% or so to limit their losses in the event of repossession in a declining market.  But over the last 10 years, home values went up about 80%, so foreclosures became profitable.  Banks, seeing this seemingly unending price increase, gradually increased their loan-to-value caps; some non-bank finance companies went as far as 120% loan-to-value loans.  When the price trend reversed, lenders found themselves holding assets that were worth less than the loans with which they were financed…

With cars, conversely, nothing of the sort happened.  There was no price run-up over the last 10 years; values were and are readily established due to an active and well-organized market in used cars (dealer and repo auctions).  Additionally, lenders have not raised loan-to-value caps on car loans, precisely because they continued to expect that car values would decline over time…

Paul Krugman on legislative acronyms

Paul Krugman writes:

There were two main Bush tax cuts — EGTRRA, enacted in mid-2001, and JGTRRA, enacted in 2003. (What do the letters stand for? All sorts of good stuff. If we ever have legislation decreeing death of the first-born, it will be named MPAPRA, the Motherhood Patriotism and Apple Pie Reconciliation Act, or something like that.)

Indeed.

Daimler in Alabama: the financials

A question from Askville:

what tax incentives did Daimler Benz get from AL

A very complicated package…

Alabama committed to paying Daimler a one-time $42 million subsidy toward constructing the plant.  The state allowed Daimler to pay no corporate income tax, as long as the entire tax break goes toward debt service on the Alabama facility.  Alabama also allowed Daimler to use some of the income tax money it withheld from employees (up to 5% of wages and salaries) for debt service.  Finally, the state committed to purchasing 2,500 locally made SUVs over a period of 10 years…  (The last commitment, however, was eventually renegotiated down to nothing.)

Source: Edwin I. Gardner Jr, Robert S. Montjoy, Douglas J. Watson (2001), “MOVING INTO GLOBAL COMPETITION: A Case Study of Alabama’s Recruitment of Mercedes-Benz,” Review of Policy Research 18 (3), 80–93.

Dani Rodrik on measuring globalization

Dani Rodrik writes:

Measuring globalization

I am not a fan such indices, but here is an index that is innovative in that it tries to measure not just economic globalization, but also “social” and “political” globalization. You can use the site to query the data base and generate your own custom tables and charts. Report back your favorite anomaly in the rankings…

One problem with such indices is that they lump together things that are conceptually distinct and which represent answers to different questions. For example, the economic globalization index is based both on the actual volumes of trade and investment and on measures of how restrictive policies are. Outcomes and policies are equally weighted.

Now, I can think of questions to which volumes of trade and investment are the answer (e.g. “how much of domestic consumption is sourced from abroad?”) and I can think of questions to which measures of policy are the answer (“how much has the government liberalized its trade regime?”). But I cannot think of any questions to which a weighted average of the two represents the appropriate answer.

Measuring the health of nations

A recent article in Health Affairs:

Measuring The Health Of Nations: Updating An Earlier Analysis
Ellen Nolte and C. Martin McKee

We compared trends in deaths considered amenable to health care before age seventy-five between 1997–98 and 2002–03 in the United States and in eighteen other industrialized countries. Such deaths account, on average, for 23 percent of total mortality under age seventy-five among males and 32 percent among females. The decline in amenable mortality in all countries averaged 16 percent over this period. The United States was an outlier, with a decline of only 4 percent. If the United States could reduce amenable mortality to the average rate achieved in the three top-performing countries, there would have been 101,000 fewer deaths per year by the end of the study period.

And here are 2002-03 amenable mortality rates by country (per 100,000 people):

health_of_nations_small.png