Tuesday, August 31, 2010
(Click on images to see details)
Sold 1,000 shares of SapuraCrest yeterday.
Received $ 888 for the month of September, just a routine saving.
Return on capital since inception = 17.77%.
$ 7,300 ++ available cash, will be handy if opportunities show up during next market correction.
The market is at the very interesting twist. More comments will come later.
Happy Birthday Malaysia. You have turned 53th years old today. Looking forward to our nation who entered the golden age will be able to display a great deal of maturity, competitiveness, wiser and full of dignity. We may be critical at times but it's an act out of love. It's my prayer that our nation will be able to continue to reform and soar to a new height.
Sunday, August 29, 2010
The market breath has been negative even though the FBMKLCI breaking many new highs. There were only two out of last ten trading days managed to have more rises than falls.
If you look at the FBM Small Cap Index - one of my indicators to measure the risk appetite - appeared to have rolled over.
From valuation stand point, it does not appear that we are at the peak of the cycle. We are slightly above 10 year PE avearage of 16.73.
Our market is kind of more expensive compared to regional valuation. You can see from the chart that regional valuation is below its historical level.
I don't think we are heading for a train wreck scenario. If we one of the most expensive, the only motivation left for foreign investors will be forex gains. If Ringgit stops gaining ground against USD, then I think the risk of our bursa to correct is high.
Saturday, August 21, 2010
MELBOURNE (Reuters) - Australia's two major parties wooed independent lawmakers on Sunday after an inconclusive election left the nation facing its first hung parliament since 1940 and set financial markets up for a sharp sell-off.
The Australian dollar and shares are likely to slide when trading resumes on Monday, analysts said, with the vote count threatening to drag on for days and both the ruling Labour party and opposition seemingly unable to win a majority.
"The uncertainty is going to be a real killer to the financial markets," said economist Craig James of Commsec, suggesting the local currency could fall a cent or more.
With 78 percent of votes counted, a hung parliament looked likely, with two possible scenarios for minority government: a conservative administration backed by rural independents or a Labour government backed by one or two Green or green-minded MPs.
I'm posting this ahead because I will be on the road for a few days.
UMW has been lagging very badly - way behind stocks like Tan Chong, Proton, MBMR. OMG, lagging behind Proton? Perhaps most people don't see it as an automotive stock? Again suffering from conglomerate discount?
If you look at the segmental results, the automotive segment is the real money spinner. It accounts for 96% of the pre-tax results.
What is so valuable in the automotive division? Short answer - great brands that it represents i.e. Toyota and Perodua. They command about 47% market share(30 June 2010). Long answer, I can write a long easy but it's not my style.
I used to bet that their O & G will contribute a significant chunk of profits to UMW. Unfortunately, it has fallen apart. Their oil division sufferred lack of expoloration activities and delayed in NAGA 2 oil rig. Their associated company in China has been slapped with higher duties on its piping export to the US market. But despite of so many Murphies running all over the place, I still think it will contribute solidly to the group.
Stronger Ringgit and automotive re-rating will be the possible catalysts. One of old catalysts was spinning of the O & G unit by listing them but it has encountered a number of false starts. So I would drop this listing catalyst for the short term.
Some fundamentals. Net cash, 13-15% ROE on this large conglomerate with RM 12 billion revenue is very respectable and 6% dividend yield give us sufficient margin of safety. It has a long list of respectable shareholders but only the summary is shown here.
Two price points to watch - KLCI 1450 and UMW previous All time highs $ 7.80. Failing to breakout from either one of these points will be the time to take profit.
Disclosure : This stock used to make me a lot of money, serious money but I have no fresh position after I sold it off in 2008.
Ajinomoto needs very little introduction. The core of their business is making food enhancer Ajinomoto. It has almost 80% market share in Malaysia. If you read their annual report, year after year they will mention that they raised price and some volume growth driving higher revenue.
This chart shows you the growth drivers. Sales have been growing at about 9% annual compounding rate. The main growth drivers are coming from Other Asian countries and Middle East. I believe it can continue to grow moderately in line with the regional prosperity growth. Secondly, Malaysia will have some advantages to produce halal foods.
Here is a snapshot of their key financial results.
Balance sheet has been very clean and strong. It has almost RM$ 56 million cash(0.92/share) and debt free. ROE around 10-12%. It's an indication they can actually return a lot more money to shareholders.
If I assume the company is going to grow roughly about 10%, applying cost of capital of 10%, based on discounted cash flow, this company worth between $ 5 - 5.50.
Let me pull out some critical stock market information that I extracted from Stock Performance Guide published by Dynaquest Sdn Bhd(This book is a must for every investor). Looking at the earning and dividend payout growth consistency , this stock has a good chance of giving total return of around 10-15% CAGR.
Disclosure: No position yet.
Friday, August 20, 2010
Roger Ibbotson is a money manager and Yale finance professor.
(Money CNN) Should investors expect superior gains from stocks in the future? Or has something changed that suggests equities won't be as dominant?
Stocks are going to outperform bonds long-term.
That's almost assured. Yes, we've had a decade where the stock market underperformed, actually had negative returns, but that was very unusual. You have to go back to the 1930s before you had another negative return for a decade in the stock market.
It makes sense, though, that we have some periods of negative returns because the whole key to getting higher returns in the long run is that stocks are risky. People have to be afraid to take the risk of investing in stocks for them to deliver superior returns going forward.
Now, future stock returns might be lower than the near 10% historical average. We think maybe 8% or so, although others say they could be even lower because they don't see strong economic growth for the next decade.
But the equity risk premium, or the extra return you get from stocks vs. less risky investments, isn't much different than it was historically. What is unusual about the last 30 years, though, is that the bond market often outperformed the stock market over long periods. You won't get that again.
You started in 1980 with double-digit yields, which provided high income, and those yields then dropped, creating capital gains. [Bond prices and yields move in opposing directions.] That combination made it a great period for bonds. But today yields are 3% to 4%. So we're starting out with a low yield that, if anything, is more likely to rise than fall, which means you won't get any capital gains. So the bond market will not repeat its performance.
The stock market can repeat, and the kind of returns you got over the last 30 or 40 years might be indicative of future returns. But they'll come with up and down periods that can be very disheartening.
Disheartened is how many investors feel about stocks today. What makes you so confident? Is there something inherent about stocks that makes them likely to outperform?
What's inherent about stocks is that they're risky. And we don't like risk. So every time something bad happens, we're really wary of the stock market. Of course, we were especially wary in March 2009 after the market had fallen well over 50%, but that turned out to be a great time to buy stocks. It's when you're most afraid of stocks that they have the most potential.
But to get this risk premium, don't you have to be correctly pricing in the risk?
Some would argue that recent prices don't reflect stocks' true risk, that price/earnings ratios are too high.
P/Es are hard to measure coming out of the recession because earnings are changing quickly, and P/Es from trailing earnings are much different than estimated P/Es from forward earnings.
The stock market surged in the early stages of the recovery not because companies increased their revenues but because they cut their costs. Now if they can start increasing their revenues, they can improve their bottom lines a lot. If that happens, stocks will turn out to have been rather attractively priced now.
You've recently started managing two mutual funds -- American Beacon Zebra Large Cap and Small Cap -- that will invest in less liquid stocks, those that trade less frequently. Why, at a time when investors are wary, would you want to focus on shares that would seem riskier?
There are gradations of liquidity. These stocks trade every day. But research shows that the stocks that are more liquid historically have lower returns, while those that are less liquid have higher returns. We're buying companies that have strong fundamentals but are relatively less liquid, companies that there's less interest in, the ones not talked about in your magazine. Effectively, you get an out-of-favor stock, and if it ever comes into favor, you get a big kick-up in the returns.
Thursday, August 19, 2010
After keeping silent for a few days, some must be guessing whether I have gone more bullish or bearish. I have spent considerable time on my blog decoding the market sentiments. I am not going to misquote Buffett here. Buffett said two things they should teach in business school
(i) how to value a business
(ii) how to think about the securities and markets
The first part is easy. With a little practise and be willing to pick up a few books, we should be able to master it.
The second part is difficult, it's all about emotions. The ability to understand human behavior. There is no book available to teach you about this. It's about self confidence to think independently.
In real life, it's difficult to find perfect companies operating in a perfectly wonderful business environment. Somehow, they will have a few weaknesses, company specific or overall poor macro-level. I can share a few of them when I can find some time over the weekend.
As a prelude, my personal opinion is all about margin of safety. It's about how much discount Mr. Market gives me for each company he is willing to sell it to me. From there, I can decide whether I like the risk and the reward. Consider these three offers:
CoA - flat earning, low gearing, selling for 4X earning, 3X Cash Flow, DY 7%. Overall market is selling for 9X PE, 2.3X BV. Price has fallen by 60% from peak.
CoB - Growing business(23% CAGR for the last 10 years), moderately geared, selling for 23X earning, 7X Cash Flow, no dividend. Overall market is selling for 19X PE, 3X BV. Stock price has broke out from a new 5-year high.
CoC - Growing business(9% CAGR for the last 5 years), cash rich, debt free, selling for 15X PE, 7X Cash Flow, 5% DY. Overall market is selling for 16X PE, 2.3X BV. Stock price has been stucked in a narrow range of +/- 10% for the past 4 years.
How would you allocate your capital?
Thursday, August 12, 2010
(The Star) CAN it be that the stock market’s love affair with rubber glove manufacturers is on the rocks amid signs that there will be no repeat of the industry boom like last year?
In addition to the slower demand growth in the rubber glove industry, analysts expect additional headwinds in the form of the weak US dollar and higher latex costs.
The share prices of the major glove makers has dropped significantly recently. Top Glove Bhd closed at RM6.20 yesterday, 14.4% lower than its highest on July 15 this year; Supermax Corp Bhd dropped from its highest of RM6.55 on July 19 to RM5.99, Kossan Rubber Industries Bhd was down 45 sen, compared to its highest of RM4.25 this year while Hartalega Holdings Bhd slipped 61 sen to RM7.84, from its highest of RM8.45 this year.
The demand of rubber gloves rose tremendously last year with a growth of about 18% due to the flu outbreak that pushed up the demand in healthcare industry, compared to its normal 10% growth previously.
The companies share prices grew hugely from last year to July supported by growing demand and the bright outlook of the healthcare industry.
Compared to its share prices on last trading day of last year with its highest point this year, Top Glove has grown 44.7%, Supermax grew 74.5%, Kossan jumped 56.5% while Hartalega has rose 35.9%.
However, analysts said the “good scene” for glove makers has come to an end as the flu outbreak is under controlled now, which caused a lower demand.
Stocks, for most of the time, are moving in a group. There will be a leader and followers. The sector can be hated for a long time when a group of institutional or major shareholders decided to exit. If sellers are exhausted themselves, perceived price is cheap enough there will be buyers out there. Some of these buyers may accumulate enough and begin to put a positive spin on it. If the leader manage to lead again, soon the shareholders in follower group will quit selling hoping they can fetch a higher price later.
(click on images to see details)
You may see the first chart shows that Top Glove is the leader. The clear pattern is they topped and bottomed out first. The most hated stock will be the last to bottom out. The leader Top Glove is rolling over recently. No matter how cheap the rest of the stocks, my suspicion is, followers will tumble soon.
Since today is Friday, I will lighten up things a little bit. The whole commentary can be best summarized by Lao Fu Zhi.
Traders will think breaking down below 1,350 will trigger selling to manage their risk. Let's see how strong this level can hold and how heavy is the selling volume.
Do you remember my last Saturday posting regarding Japanese Yen flashing yellow light and I said coming 5-10 trading days will make things clearer. The picture indeed becoming clearer.
Sunday, August 8, 2010
One of the very common indicators is price-to-income ratio. Since I can't find one for Malaysia's context, I am using Australian example here.
(Click on the chart to see the details)
As you can see in the chart, price-to-income of 3 - 4 times is okay.
Malaysian median household income of urban area is about RM 4,000 per month. Basing on price-to-income of 3 - 4 times, fair value of a double-storey terrace should be around RM 140,000 to RM 192,000.
Income per household could be too general and I feel it's a bit on the low side for Penang. I think a professional household in urban area would have gross income of RM 8,000 - RM 10,000. Based on this assumption, an urban fair value for a double storey property will be around RM 400,000-RM 500,000 max. The current price between RM 700,000 - RM 1,000,000 is pushing price-income ratio to 7 - 10 times. It's high!
The other indicator is debt-to-income ratio. The rule of thumb is this ratio should be below 0.30 times. Back to the assumption of RM 10,000 urban husband-wife professional household monthly gross income, the maximum monthly housing payment affordability should be around RM 3,000.
You can calculated your affordability by visiting this website:
(I avoided direct link to prevent abuses by crooks to redirect my readers to unauthorized website)
By punching in some numbers, you can see that the maximum property that a family with RM 10 k income can afford up to around RM 600,000. These assumptions are quite generous, for some reasons, the loan price war stop among banks and we are facing higher inflation, driving BLR to 7%, a fair value of a double-storey terrace will drop quickly to around RM 500,000. Anything above this value is speculative.
My other favorite chart is by just looking out for a hockey stick or parabolic rate of price change(see the US example).
If inflation adjusted price is too abstract to you, see USA major cities house prices in September 2005 when it was almost at its peak. The number was less than 1 million, looks very affordable but they did not know that they were in a bubble.
Basing on various models, I would say Penang island housing market is over-priced at least between 40 - 100%. The houses can remain over-valued for a long time as long as people still have their jobs.
Saturday, August 7, 2010
The first article is making a hue and cry(CPCB) that we are in a speculative market.
(The Star)SINCE the last quarter of 2009, property prices have not gone up incrementally. They have escalated, especially for landed units. In certain locations, prices may be unsustainable.
Up to the first quarter of this year, intermediate two-storey houses in a popular part of Petaling Jaya were transacting at about RM650,000.
Yesterday morning, an agent said the company had sold several houses facing T-junctions (which are not popular units among buyers) in the same township. These were 2 1/2-storey houses. One was sold for slightly more than RM1mil, among the highest he has ever seen in that location for a house located opposite a T-junction while another was sold for RM950,000, the lowest among the three.
Even at RM950,000, he felt that it was rather high. He is also rather concerned about valuations these days. “I like this property business. I want it to grow. But not this way!” he said.
In certain locations, especially in gated and guarded communities, it has come to a point where valuers are reluctant to put a value on a property.
How do you pin a value on a house when next month the price will be different? Prices are simply moving too fast.
Due to pressure, the valuer may have to value it. If the previous transaction was RM1.6mil, he may then reluctantly value the next one at RM1.63mil. The result is that the price of houses in that gated and guarded development becomes increasingly higher. It eventually becomes a speculator’s market, not a buy-to-stay market.
The second article was trying to put a perspective of valuing the property based on P/E ratio(20 times PE and 4% ROI is okay).
(The Star)Calculation of P/E ratio for a property investment evaluation is pretty straight forward. For a house that yields a rental income of RM1,000 per month, that works out to be RM12,000 per year. With the house valued at RM240,000 that derives to a P/E ratio of 20 times. Based on my experience, this rate seems to be the valuation point of landed properties in the Klang Valley. To be more accurate, some would deduct direct expenses to derive at the net rental income less expense. Rates lower than these could either entail a bargain or a low valuation placed by investors, while rates above would translate as either a premium, or over valuation by investors.
We can also calculate the annual Return on Investment (ROI), simply by dividing the annual rental against the investment value, and this derives to 5%. This is actually the inverse of the P/E ratio, whereby 1 divided by 20 gives 0.05 or 5%.
What this means is that at 5% annual ROI, it will take 20 years (at current rate excluding inflation and other factors) to recoup the investment.
The P/E ratio can also be used if you are evaluating to sell your property (besides having a market price evaluation). For instance, if you had purchased a RM240,000 property, and three years down the road the rental has increased to RM18,000 per annum. Assuming the property P/E ratio remains, then the property should have a valuation of RM360,000 (RM18,000 X 20). This represents a three year cumulative average growth rate (CAGR) of 22.5% which can form a benchmark.
Prelude. Why people are attracted to property market?
The answer is obvious, you can make fast and easy money. How? Let me find you a real life case study.
I am sure that everyone loves SP Setia. They are more solid than gold. This was one of the comments when the project was first launched. It was around RM 700,000 in 2008for 2.5 storey terrace house - 20 x 70.
This is the latest happening when the project completed. Wow many units available-lah but still expensive!
Let's say the guy manage to push it out for about RM 800 k with original cost of RM 700 k. So what kind of return is he getting?
Let's assumed he managed to secure a rock bottom loan of BLR - 2.3% during 2008, he funding cost was around 2.9% for 2 years.
Husband and wife have a combined gross income of RM 8,000. So the bank was offering 90% margin, so his downpayment was RM 70,000(his capital).
Let's say based on 2.9% p.a. interest, he served bank interest of RM 35,960 and forget about the exit penalty for early settlement.
Now he pocketed a tidy profit of RM 64,040.
So his return of investment is 64,040/70,000 = 91%.
Whalao.....this return is damn so good-lor.
This is the magic of LEVERAGING, especially with very low funding costs.
Let's say he just managed to push it out at RM 750,000.
His profit was only RM 14,040 - BUT - ROI is 14,040/70,000 x 100 = 20%. Still not so bad.
He was patience enough, the property price jumps from original RM 700 k to RM 1 million in 3 more months.
The potential profit is even more fantastic, RM 264,040 or ROI of 377% over a period of 2 years.
Now do you understand how great is the temptation to get into this asset class?
Almost guarantee "no lose money", high margin from bank, SP Setia price for new launches getting higher = very high return, surely beats Warren Buffet's returns, can retire in 5 years time(flip for 3-4 times enough-lor). So what are you waiting for?
Found a good answer of Japanese Yen strength vs. US Dollar on Kathy Lien's blog(http://www.kathylien.com/site/). She said the 2 years US treasury yield has been in downtrend and moving in locked-step with Japanese Yen. The yield has been declining in anticipation of weak US economy(soft patch) causing the weak US dollar. This was confirmed yesterday when 2 yr treasury yield dipped below 0.5% after released of very slow jobs addition and unemployment was still high at 9.5%. So people will have to sell dollar and buy Japanese Yen to unwind their position.
Bill Gross said the fed is unlikely to raise interest rate for 2-3 years.
(Bloomberg)Pacific Investment Management Co.’s Bill Gross said the Federal Reserve is unlikely to raise interest rates for two to three years as it seeks to keep the economy from slipping back into recession.
Treasury two-year note yields dropped below 0.50 percent for the first time today after the Labor Department said the economy lost more jobs in July than economists forecast. The difference in yields between 2- and 10-year notes is 2.33 percentage points, more than double the average of 1.11 percent for the so-called yield curve over the past 20 years. The spread reached a record 2.94 percent on Feb. 18.
“When you analyze that portion of the curve, it says the Fed is on hold for a long, long time,” Gross, said today during a radio interview on “Bloomberg Surveillance” with Tom Keene. “When you get down to 50 basis points on two-years, that’s giving you a signal that there’s not much left on the table.”
Many of my readers must be wondering why am I posting some of these hard and dry stuffs. There are many investment implications actually. Care to offer some comments/suggestions?
Friday, August 6, 2010
I am not an expert in these areas but as an investor, I certainly need to think about this issue so that I will not be caught with my pants down. After following the financial crisis stories for a while, I think there were a few thinkings out there trying to explain why we had 2008 financial crisis.
1. Slow reaction of Fed to raise interest rate creating excessive liquidity finding its way into housing bubble.
2. Over-saving Asian countries are funding over-consuming American because they have no place to recycle their money. This self-reinforcing loop created the global imbalances.
3. Market knows best will sort out all the problems by itself. Government should stay out of the market. Long lives MARKET FUNDAMENTALISM!
4. Like all bubbles, the party has to come to an end. When natural cleansing process set in to correct all excesses - house prices began to collapse.
5. Complex and lack of monitoring of complex financial derivatives finding it difficult to value its securities that were rarely traded. Lack of price discovery mechanism triggered fire sale that keep bringing down the value to, almost ZERO???.
6. Over-leveraged and under-capitalized banks just could not withstand shocks when these proverbial stuffs hitting the fan.
7. The global financial markets coupling much more stronger than we thought it was -- de-coupled.
Back to the issue of China and Taiwan's stress tests. I am sure with them staffed with 100 of PHDs, they will be able to keep the mechanism in place to fight the property bubbles that at its infancy. Chances of their conclusion will be okay at this point of price level.
However, what they must recognize is this, price is not static but dynamic. It could go up another 1,000% before they collapse(just an over-exaggeration here). The prescription will certainly has to be modified. The amount of capital adequacy needed by banks could be very different.
What if the obvious housing bubble was not the problem. What if bubbles find its way into some other asset classes? What if Sovereign Funds chasing after few other classes creating other bubbles? What if developed countries continue to drop money from helicopters? Well, they should be thinking of black swans --- thinking things are less obvious and unthinkable.
They must go back to the root of the problem - fight that damn liquidity. My bet is they are afraid to tighten it too quickly fearing choking the recovery process. There is no way they can time it right, regulators have been wrong as frequent as weather forecaster's' call. Did I raise the correct big picture questions? Well stop worry things that I can't control.
As an investor, I should remember this day and night. Be fearful when others are greedy, be greedy when others are fearful. At some point of time, I'll keep my money under the mattress. But at this point of time, people have not been too greedy yet.
(Bloomberg)Taiwan regulators asked lenders to conduct stress tests to gauge the impact of a 25 percent drop in home prices amid concern speculators have driven the market too high, said Johnson Chung, head of mortgages at Ta Chong Bank Co.
“The regulator is doing the stress test because the government is concerned about banks’ exposure to the property market,” Chung said in a telephone interview today. He said officials are also concerned that “hot money” may create a bubble in asset prices.
China's stress tests
China’s stress tests of banks will assess the risk that a possible slump in property prices may strain developers’ finances and cause homebuyers to default, a person with knowledge of the matter said this week.
The banking regulator told lenders to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in this year assumed home-price declines of as much as 30 percent.
Thursday, August 5, 2010
(Bloomberg)Bill Gross, who runs the world’s biggest mutual fund, takes a seat in a conference room and makes a confession. Overlooking the ocean at the headquarters of Pacific Investment Management Co., Gross describes missteps that doomed his bond firm’s experiment with equities in the mid- 1980s.
At meetings where Pimco set its strategies, Gross’s bond traders overwhelmed the firm’s handful of equity managers, shooting down their bullish arguments promoting stocks. With limited freedom to pursue their own investing ideas, the equity managers quit after about two years, Bloomberg Markets magazine reports in its August issue.
“Those sessions basically said, ‘Hey, we’re a bond shop. This is what we’re going to do. It’s the party line,’” Gross, 66, says. “If I’ve been a problem, then I can be the solution in terms of allowing equity investments to grow and prosper.”
Pimco, which has been synonymous with bonds for almost four decades, is taking another run at equities. It may not be the most propitious time to plunge into stocks. Volatility, as measured by the Chicago Board Options Exchange Volatility Index, was at a 14-month high in late May, as the sovereign debt crisis swept through Europe.
Driving Pimco’s move into equities is Chief Executive Officer Mohamed El-Erian, who says the global economy is entering a period of fundamental transformation he calls the “new normal.”
El-Erian says mounting deficits and tighter financial regulation will dampen growth in the U.S. and the euro zone for the next three to five years. Emerging-market nations such as Brazil and China, with stable levels of government debt and expanding middle classes, should continue to thrive, he says.
In the new normal, investors will be faced with anemic returns and they’ll seek alternatives, says El-Erian, who’s embracing several new asset classes. In the past year, he’s presided over the creation of an equity mutual fund and a unit to invest in hedge, real estate and buyout funds. Pimco has also started 10 exchange-traded funds.
“We are living through a remarkable time of change,” says El-Erian, 51, who shares the title of chief investment officer with Gross. “We want to make sure we navigate the changes for our clients.”
Not everyone agrees with this analysis from Newport Beach, California-based Pimco. Some U.S. cabinet officials and securities analysts say El-Erian’s new normal is off the mark.
End to Bond Rally
More than 2,000 forecasters set price estimates showing the Standard & Poor’s 500 Index will jump 26 percent in the 12 months through May 2011 as corporate profits rise, according to data compiled by Bloomberg.
Some investors say the firm might be better off sticking to what it knows best. Gross’s flagship Pimco Total Return Fund, using a complex concoction of bonds, futures and credit-default swaps, has outperformed 97 percent of its fixed-income rivals during the past decade.
“When a fund company expands into new business lines, I get very nervous,” says Martin Weil, whose Healdsburg, California- based MW Investment Strategy Group Inc. manages $30 million, much of it in Pimco funds. “I have a very high degree of respect for Pimco. Am I going to dive into their equity offerings? No, but I’ll take a look.”
The three-decade rally in bonds, the very securities that made Gross famous, will eventually fizzle out, according to Pimco’s outlook. Gross says the rally will come to an end as nations sell record amounts of debt to fund their deficits, spurring a return of inflation and rising interest rates.
Bonds Best Days
“Bonds have seen their best days,” says Gross, who anticipates returns of 4 percent to 5 percent in the new normal.
The king of bonds is now talking up stocks as a better long-term investment. He says that as U.S. Treasury returns fall, investors will have to take more risk with high-yield bonds, equities and, eventually, real estate.
“If you’re talking about the next 10, 15, 20 years, there’s certainly the recognition that assets will grow faster in those categories,” he says. “Over the long term, stocks return more than bonds when appropriately priced at the beginning of an investment period.”
Gross’s prophecy on bonds may not be coming true anytime soon. Since May, when he warned that European nations like Greece can’t rely on growth to finance their soaring deficits and would likely default, investors have poured into U.S. Treasuries.
While Pimco estimates that U.S. debt has the potential to soar to 90 percent of gross domestic product, the country remains a haven for investors. Even Gross increased his Total Return Fund’s holdings of government-related debt, which includes U.S. Treasuries, in May to the highest level since November. The yield on the 10-year Treasury note fell to 3.12 percent as of 5 p.m. yesterday.
Spearheading Pimco’s push into equities is EqS Pathfinder, a global fund the firm launched in April that buys undervalued securities, mainly in Europe. Its only U.S.-based holding in the top 10 positions is SPDR Gold Trust, an ETF that buys gold. Most of Pathfinder’s major positions -- British American Tobacco Plc, French foodmaker Groupe Danone SA and Hong Kong-based Link Real Estate Investment Trust -- derive at least part of their earnings from emerging markets. Pathfinder, which had attracted more than $500 million, declined 1.7 percent in the month ended on June 7, beating 96 percent of similarly managed funds, according to Bloomberg data.
Bond View of Equities
Some analysts say Pimco’s exceptional performance with bonds gives it an advantage with all investments. In Europe, widening bond spreads last year were a warning sign for equity investors of the looming debt crisis, which sent European stocks to an eight-month low on May 25, says Cynthia Steer, chief research strategist at Darien, Connecticut-based Rogerscasey.
“It’s a needed look at equities through the bond view,” says Steer, whose firm oversees $265 billion in assets for institutional investors, many of whom have money with Pimco. “Their research on sovereign debt is excellent, bar none.”
With $1.1 trillion in assets, Pimco is expanding into stocks as part of an effort to lure more individuals to its funds. They’re the fastest-growing group of investors, accounting for 84 percent of all U.S. mutual fund assets at the end of 2009, according to data from the Investment Company Institute in Washington.
Individuals also pay more than institutions. The Total Return Fund charges retail customers annual expenses starting at more than 1 percent of assets compared with less than half of that for institutional and 401(k) investors.
Pimco’s income helped fuel the robust results in the first quarter at the asset management unit of its parent, Munich-based insurer Allianz SE. The unit’s operating profit jumped 121 percent to 466 million euros ($555.6 million) from a year earlier -- a figure that helps explain Allianz’s hands-off approach to Pimco.
“They really have left us alone,” Gross says.
As Pimco increases its use of ETFs, it lags behind BlackRock Inc., the world’s biggest fund manager, with $3.36 trillion in assets. New York-based BlackRock last year bought Barclays Global Investors mainly to get iShares, the No. 1 manager of ETFs, with $509 billion in assets.
The securities, which trade on exchanges, have soared in popularity by offering lower taxes and fees than mutual funds. Pimco controls only about $1 billion in its ETFs, with three actively managed bond funds and seven others that track indexes linked to U.S. Treasuries.
Worrier By Nature
The two men responsible for plotting Pimco’s strategy share adjoining desks. Their personalities couldn’t be more different. El-Erian deliberates over almost every decision, while Gross often acts out of instinct. At a round wooden table in a 10- foot-by-10-foot (3-meter-by-3-meter) conference room that served as Pimco’s first bond-trading floor, El-Erian, the son of an Egyptian diplomat, says he’s a worrier by nature. When he was 10 years old, his mother, who’s French and Egyptian, urged him not to take life so seriously.
“She said to me, ‘If you don’t have something to worry about, you create something to worry about,’” says El-Erian, who runs day-to-day operations at the firm of 1,300 employees. He worked over the details of starting stock funds for some two years.
Gross, who directly manages 24 mutual funds, relies on his gut, as well as endless reams of data.
“He is much bolder,” El-Erian says. “He has this amazing instinct. I’ve never seen anything like it.”
Both men get to work at 5 a.m. -- before the start of trading on Wall Street -- and take their seats in the middle of a tightly packed trading floor that overlooks a parking lot. Gross is surrounded by seven computer screens with two stuffed animals -- a bull and bear -- sitting on top of them; El-Erian uses four monitors.
The two leaders rarely speak to one another on the floor. Gross enforces a policy of near silence, sometimes by glaring at offenders who talk too loudly.
“I think Mohamed is respectful of my, sort of, isolation,” says Gross, sitting in the conference room with his blue-and-red printed tie unknotted. “You wouldn’t find me walking around giving high-fives.”
El-Erian, on the other hand, enjoys creating camaraderie around the office. In January, he planned a surprise celebration on the trading floor for Gross. Morningstar Inc. had named him the fixed-income fund manager of the decade after earning a 10- year annualized return of 7.7 percent in the Total Return Fund. The CEO even found a bakery to deliver a cake at 4:45 a.m. As Gross arrived to work, traders erupted in a standing ovation.
Too Much Sugar
“Which is about the last thing he wanted, because then he had to say something,” El-Erian says. Gross spoke briefly, thanking everyone.
Gross, who keeps fit doing yoga and riding a stationary bike for 90 minutes a day, also said he didn’t like to eat that amount of sugar so early in the morning. “It only happens once a decade, so don’t worry about it,” El-Erian responded.
The two executives do constantly communicate, often debating investment ideas, mostly through e-mail. The exchanges go on and on through weekends. “He’s unrelenting and indefatigable,” Gross says.
One thing El-Erian and Gross share is a penchant for publicizing their investment views, which can sometimes move markets. On Nov. 19, Gross wrote in his Investment Outlook on Pimco’s website that utility stocks were attractive with dividend yields of 5 to 6 percent. On that day, the Dow Jones Utilities Average of 15 stocks took off and hit a one-year high in less than a month.
High Jobless Rate
El-Erian frequently touts the new normal on financial news shows and his firm’s website. An economist with a Ph.D. from Oxford University, El-Erian argues that the U.S. faces structural and long-lasting economic burdens, such as massive public debt. He says the U.S. jobless rate -- 9.7 percent in May -- will remain elevated for the foreseeable future. In May 2009, he said that the U.S. economy would expand at an annual rate of 2 percent or less in the next several years -- a forecast he hasn’t revised.
After El-Erian presented his outlook last year, the U.S. economy grew 3 percent in the first quarter, suggesting that the new normal was too pessimistic. El-Erian says the expansion will slow as federal stimulus spending dries up, and May’s job report supports his view. The economy created only 41,000 private- sector positions -- a drop from the 218,000 nongovernment jobs produced in April -- and not enough to make a dent in the unemployment rate.
‘The Old Cyclical’
In an April speech at Princeton University, Christina Romer, head of the White House Council of Economic Advisers, said she found the fatalism of the new normal distressing. Romer said that shorter-term cyclical events like the drop in demand were the real drag on job creation.
“Unemployment is high fundamentally because the economy is producing dramatically below its capacity,” Romer said. “That is, far from being the new normal, it is the old cyclical.”
El-Erian’s biggest challenge may be internal. As the CEO builds a stable of new funds, he’ll have to overcome the embedded bias for bonds that took root in 1971 with the founding of the company. When Gross and his two bond-trading partners left Pacific Mutual Life Insurance Co. to set up their own firm across the street, they decided against taking an equities manager with them.
“It would have been better to bring the equity person,” Gross says. “We would have been balanced from the beginning.”
Decades later, the then-parent company of Pimco took a stab at stocks that ended in a legal scandal. In 1999, Pimco Advisors Holdings LP started Pimco Equity Advisors. The stock unit was separate from Gross’s bond shop and didn’t provide any financial benefits. Yet the equity group hoped to get a boost from the success of Gross’s business by taking the Pimco name.
The equity managers got off to a fast start, almost doubling assets to $9.6 billion by 2000 before running into legal trouble. In civil complaints, the Securities and Exchange Commission and New Jersey’s attorney general accused the equity unit in 2004 of allowing a hedge fund to engage in market timing, a practice of making short-term trades to exploit market inefficiencies.
Following the lawsuits, Gross said that he regretted allowing the group to use the Pimco brand. The equity unit, which didn’t admit or deny wrongdoing, paid a combined $68 million in fines and repayments to investors to settle the lawsuits. Allianz dissolved the stock group after the settlements. Allianz spokesman Eduard Stipic declined to comment on the lawsuits beyond previous statements.
Pimco learned a lesson from the fiasco. “We don’t do well when we rent our brand,” El-Erian says.
This time, Pimco will control the equity funds and integrate them into the firm. And, true to form, the CEO in 2008 rolled out an elaborate method to involve every part of Pimco in choosing new assets to manage.
He gave executives a spreadsheet matrix and asked them to use the color green to indicate markets the firm should enter because it has the experience to do so. Yellow meant areas the company should pursue but doesn’t have the know-how. Red signaled businesses to avoid. Portfolio managers used the matrixes to rank ideas for specific funds, and sales reps indicated their clients’ preferences using the colors too.
“We got all these matrices back, we put them on top of each other and we had this overlapping matrix approach that resulted in a road map for Pimco,” El-Erian says. Asset-allocation funds, which invest in a variety of securities, earned a green; equities, a yellow; and direct private-equity investments, a red.
In keeping with Pimco’s bearish view on America, the firm doesn’t plan to create funds with a focus on U.S. blue chips.
“We’re not going to launch a large-cap U.S. fund,” says Neel Kashkari, who heads Pimco’s move into new asset classes.
Kashkari, 36, a former investment banker at Goldman Sachs Group Inc., has no experience in asset management. Then-Treasury Secretary Henry Paulson tapped him in 2008 to oversee the $700 billion Troubled Asset Relief Program.
After TARP bailout money was doled out to banks, Kashkari endured a grilling in Congress. In 2009, Representative Darrell Issa, a California Republican, and other congressmen blasted Kashkari for failing to require transparency on how the banks used the money. Kashkari told lawmakers at the time that TARP was attempting to increase its transparency.
He resigned in May 2009 as part of the outgoing Bush administration. As of the end of March, 77 TARP recipients had paid back $180.8 billion of the $496.8 billion the fund has distributed.
“Given my experience building the TARP from scratch, I wanted to build new businesses in the private sector,” says Kashkari, who declined to elaborate on the bailout program. At Pimco, he plans to start fewer than 10 equity funds in the near future. “You will see us offer a handful of strategies that are global,” he says.
El-Erian forged his career analyzing the global economy, first at the International Monetary Fund in 1983. A former colleague says El-Erian was known for a work ethic that once kept both of them up until 3 a.m. writing a research report. He ascended from an entry-level post to become chief of staff to Stanley Fischer, then the No. 2 IMF official, in 1994.
“He was just terrific in that job,” says Fischer, 66, who’s now governor of the Bank of Israel. “The only problem I had with him was, he wasn’t in the job long enough.”
Salomon Smith Barney
After less than a year with Fischer, El-Erian became deputy director of the Middle East department, a job he held until he joined Salomon Smith Barney in January 1998.
As the European head of emerging-market research at Salomon in London, El-Erian made a prescient call on Russia. In early 1998, he said the country would default on its sovereign debt and devalue the ruble. In making his case to clients, El-Erian said Russian credit was deteriorating and the nation’s regulators didn’t have the flexibility to respond. Russia defaulted in August 1998.
Gross offered El-Erian the job of managing Pimco’s emerging-markets portfolio three months later. From April 1999, when he joined Pimco, to the middle of 2004, his flagship Emerging Markets Bond Fund posted an annualized return of 21.3 percent.
The Harvard Management Co. board hired El-Erian in October 2005 to be CEO and revamp the university’s endowment, which was in turmoil. Prior to El-Erian’s arrival, about 30 managers, including the entire fixed-income team, and CEO Jack Meyer had left amid criticism from alumni who said they were overpaid. Some managers had pocketed as much as $35 million a year.
Under El-Erian, the payroll went down as he hired managers who were compensated using an existing formula that paid new employees less. El-Erian was the top earner at the endowment in fiscal 2007, making $6.5 million.
In overseeing teams at Harvard that focused on U.S. and emerging-market equities as well as real estate and commodities, El-Erian gained experience that would help him lead Pimco’s expansion. At Harvard, in addition to creating a foreign- exchange group, he developed tail-risk hedging, which involved using portfolio insurance to try to protect investors from unexpected events that would hammer markets. In fiscal 2007, the then-$34.9 billion endowment posted a 23 percent return.
El-Erian says he didn’t realize a financial tsunami would devastate markets a year later when he announced his departure in September 2007. At the time, mortgage delinquencies were rising and credit markets were just beginning to tighten.
‘Plan for Succession’
“I had no idea that such a big crisis was coming,” he says. “If I knew, I would have stayed there.”
The endowment performed well for months after El-Erian left for Pimco in December 2007. It rose 8.6 percent while the S&P lost almost 15 percent in the fiscal year ended on June 30, 2008.
Six months later, Harvard began to go into a financial tailspin and would pay banks almost $1 billion to terminate wrong-way bets on interest-rate swaps made prior to El-Erian’s arrival. The endowment, down to $26 billion, fell 27.3 percent in fiscal 2009.
Gross, then 64, brought back El-Erian to be co-CEO with William Thompson, who retired at the end of 2008. “Your most important job, certainly in your 60s, is to plan for succession,” Gross says. “We knew that Mohamed could fill an important part of the puzzle.”
World’s Biggest Fund
The $227.9 billion Total Return Fund became the world’s biggest mutual fund in 2009, as Gross lured in investors with his handling of the financial crisis. Gross saw the mortgage debacle coming and was able to dodge most of the damage -- thanks partly to yoga.
In 2005, he suspected a housing bubble had formed. During a yoga session, it occurred to him to send analysts posing as homebuyers into the field to test his theory. The research helped him decide as early as 2005 to avoid subprime-mortgage- backed securities.
While Gross shunned subprime debt, he hasn’t shied away from other complex investments in his Total Return Fund. Morningstar analyst Eric Jacobson says the manager boosts returns partly by using derivatives -- contracts whose value is derived from stocks, bonds, loans and currencies.
Gross increased his holdings of CDSs in 2009 as the sovereign-debt crisis began to shake Europe. The fund sold insurance on credit from countries such as Italy and the U.K. and almost doubled its CDSs on sovereign debt to about $1.4 billion on Dec. 31 compared with three months earlier, according to Pimco’s February filing with the SEC. The manager boosted his bet in the first quarter, selling default protection covering almost $5 billion in sovereign debt on countries such as Brazil, France, Panama and the U.K.
Gross also buys forward contracts or futures on Eurodollars, Treasuries and other investments, typically putting down a 5 percent to 6 percent margin deposit, according to Pimco filings. He then deploys the money that he saved by not buying the actual investments in short-term cash equivalents such as commercial paper, Jacobson says. The fund owns no bonds from Greece, Portugal or Spain.
Lawrence Weinman, an independent financial adviser who manages about $20 million in Los Angeles, steers his clients away from Gross’s handiwork. “You don’t know what’s in it,” says Weinman, who worked at Morgan Stanley and Societe Generale SA. “Putting money in with Bill Gross and saying, ‘Just put it anywhere you want,’ is not the way I advise people to invest money.”
Some traders accuse Pimco of crossing the line from market influence to market manipulation. In a lawsuit filed in 2005, two individual investors and a derivatives-trading firm claim that Pimco artificially drove up prices of Treasury futures on the Chicago Board of Trade.
The suit claims that Pimco bought $16 billion worth of 10- year Treasury futures and then hoarded a majority of the most desirable notes underlying those contracts to drive up the value of securities traders needed to fulfill their futures agreements. The plaintiffs, who are seeking $600 million, had sold the contracts short and claim they had to pay higher prices to replace them.
The U.S. Supreme Court in February let stand a federal appeals court ruling that the traders who filed the lawsuit in Chicago could pursue the litigation as a class action. Pimco denies the allegations.
‘Drip, Drip Approach’
“The plaintiffs include hedge funds and other sophisticated investors who made speculative investments and are now trying to profit from what turned out to be their bad bets,” a Pimco spokesman says.
Pimco won’t become a powerhouse in equities anytime soon. The company has hired only about 12 executives, managers and analysts to work in stocks, ETFs and funds of funds, with plans to add several more.
“In terms of the drip, drip approach of doing this slow, I can’t say it’s going to be successful,” Jacobson says. “But they want to make sure everybody they bring in is not only Pimco caliber, but also Pimco style in their thinking.”
El-Erian says he’s expanding cautiously to avoid damaging the main bond business upon which Pimco is built. “We are very careful not to dilute what has served our clients well,” he says. “And that comes from being very realistic about what you can deliver.”
Anne Gudefin and Charles Lahr, the value-oriented managers who run Pimco EqS Pathfinder, aren’t in a hurry to buy stocks. In December, El-Erian hired the duo, who had managed Franklin Templeton Investment’s Mutual Global Discovery Fund. Their Pathfinder fund held about 22 percent of its assets in cash as of the end of April.
‘We’ve Grown Up’
Following the 10 percent plunge in the MSCI World Index in April and May, the managers may deploy more money. “We’re happy to say that the current sell-off is highlighting some interesting opportunities,” the managers said in an e-mail.
Thirty-nine years after he founded Pimco, Gross says the firm’s new funds are a sign of his own evolution.
“It simply means perhaps we’ve grown up, and I have,” he says. “I’m 66 now and recognize there are lots of different pieces to a puzzle and they each have a right to a place in the capital markets.”
Gross says he has no plans to retire. But as he prepares for succession, this may be one of the last chances for the king of bonds to help his equity managers thrive and share the Pimco limelight.
Tuesday, August 3, 2010
(Bloomberg)Federal Reserve policy makers signaled they will probably pass on providing more stimulus at their Aug. 10 meeting and wait to see if signs of weaker economic growth persist.
Chairman Ben S. Bernanke told lawmakers in South Carolina yesterday that consumer spending is “likely to pick up” amid a “moderate” expansion. St. Louis Fed President James Bullard said on July 29 that he expects the “recovery will continue through the fall.” Three days earlier, Philadelphia Fed President Charles Plosser said in a Bloomberg News interview that calls for more Fed stimulus “are premature.”
Officials indicated they may ease more should the economy falter after reports of a flagging housing industry and persistently high jobless rate. Options include strengthening the pledge to keep interest rates around zero, cutting the rate the Fed pays on excess bank reserves, or buying more Treasuries or mortgage bonds. No consensus has emerged among policy makers for any of those actions, remarks by officials show, and Bernanke didn’t mention them in a speech yesterday.
“You have to get a significant downward revision to their forecast that spills over into next year” to get the Federal Open Market Committee to vote for more easing, says Laurence Meyer, a former Fed governor and vice chairman of forecasting firm Macroeconomic Advisors LLC in Washington.
“The only thing that could push the committee to ease, or a signal that tightening is even further off, might be a worse- than-expected employment report,” he said.
Monday, August 2, 2010
(Click on the image to see details)
Added $ 888 saving to August.
Had a big reversal in Turtle portfolio after lying low in the last two punishing months. Return on capital is 18%.
Thanks to Ananda Krishnan for taking Tanjong private. It certainly helps to boost Turtle's return. Taking his offer of 21.80/share generating about 35% return but at today's market price is 31% only. This is the right way to treat minority shareholders with a fair cash out offer.
Turtle is still short of 12% to achieve target of roughly 10% per annum. Looks pretty tough even though Turtle is still 7 months away to 3rd anniversary.
Sunday, August 1, 2010
(WSJ)Twenty-one years ago, Li Lu was a student leader of the Tiananmen Square protests. Now a hedge-fund manager, he is in line to become a successor to Warren Buffett at Berkshire Hathaway Inc.
Dennis Berman tells the story about one of the leaders at Tiananmen Square who is now one of the top candidates to manage Berkshire Hathaway's investment portfolio.
Mr. Li, 44 years old, has emerged as a leading candidate to run a chunk of Berkshire's $100 billion portfolio, stemming from a close friendship with Charlie Munger, Berkshire's 86-year-old vice chairman. In an interview, Mr. Munger revealed that Mr. Li was likely to become one of the top Berkshire investment officials. "In my mind, it's a foregone conclusion," Mr. Munger said.
The job of filling Mr. Buffett's shoes is among the most high-profile succession stories in modern corporate history. Mr. Buffett, who will turn 80 in a month, says he has no current plans to step down and will likely split his job after he leaves the company into separate CEO and investing functions. Mr. Li's emergence as a contender to oversee Berkshire investments is the first time a name has been identified to fill the investment part of Mr. Buffett's legendary role.
The development illustrates that Berkshire is moving toward putting in place—possibly sooner than investors anticipated—certain aspects of its succession plan.
The Chinese-American investor already has made money for Berkshire: He introduced Mr. Munger to BYD Co., a Chinese battery and auto maker, and Berkshire invested. Since 2008, Berkshire's BYD stake has surged more than six-fold, generating profit of about $1.2 billion, Mr. Buffett says. Mr. Li's hedge funds have garnered an annualized compound return of 26.4% since 1998, compared to 2.25% for the Standard & Poor's 500 stock index during the same period.
Mr. Li's ascent on Wall Street has been no less dramatic. He spent his childhood shuttling between foster families after his mother and father were sent to labor camps during the Cultural Revolution. After the Tiananmen Square protest, he escaped to France and came to the U.S. Investors in his hedge fund have included a group of senior U.S. business executives and the musician Sting, who calls Mr. Li "hardworking and clever."
From the Archive
Want to Be the Next Warren Buffett? The Line Forms in Nebraska Buffett Is on the Hunt for Next Head Investor Mr. Li's investing strategy represents a significant shift for Mr. Buffett: Mr. Li invests chiefly in high-technology companies in Asia. Mr. Buffett typically has ignored investments in industries he says he doesn't understand.
Mr. Buffett says Berkshire's top investing job could be filled by two or more managers who would be on equal footing and divide up responsibility for managing Berkshire's $100 billion portfolio. David Sokol, chairman of Berkshire unit MidAmerican Energy Holdings, is considered top contender for CEO. Mr. Sokol, 53, joined MidAmerican in 1991 and is known for his tireless work ethic.
In an interview, Mr. Buffett declines to comment directly on succession plans. But he doesn't rule out bringing in an investment manager such as Mr. Li while still at Berkshire's helm.
"I like the idea of bringing on other investment managers while I'm still here," Mr. Buffett says. He says he doesn't preclude making a move this year, though he adds that there is no "goal" to bring on an additional manager that quickly either. Mr. Buffett says he envisions a team approach in which the Berkshire investment officials would be "paid as a group" from one pot, he says. "I don't want them to compete."
Mr. Li fits the bill in some important ways, Mr. Buffett says. "You want someone" who "can think about problems that haven't yet existed before," he says. Mr. Li is a contrarian investor, loading up on BYD shares when they were beaten down. And he's a big fan of Berkshire, which may also help his cause. "We don't want them unless they have special feelings about Berkshire," Mr. Buffett says.
But hiring Mr. Li could be risky. His big bet on BYD is his only large-scale investing home run. Without the BYD profits, his performance as a hedge-fund manager is unremarkable.
It's unclear whether he could rack up such profits if managing a large portfolio of Berkshire's.
What's more, his strategy of "backing up the truck," to make large investments and not wavering when the markets turn down could backfire in a prolonged bear market. Despite a 200% return in 2009, he was down 13% at the end of June this year, nearly double the 6.6% drop in the S&P-500 during the period.
Mr. Li declines to discuss a potential Berkshire position, saying only that he feels fortunate to be a member of the Berkshire inner circle. "This is the stuff you can't conjure in dreams," he says.
Mr. Li was born in 1966, the year Mao Zedong's Cultural Revolution began. When he was nine months old, he says, his father, an engineer, was sent to a coal mine to be "re-educated." His mother was sent to a labor camp. Mr. Li's parents paid various families to take him in. He was shuttled from family to family for several years until moving in with an illiterate coal miner, with whom he developed a close bond, in his hometown of Tangshan. Living apart from his family as a child taught him survival skills, Mr. Li says.
He was reunited with his family, including two brothers, by age 10, when a massive earthquake hit his hometown, killing an estimated 242,000 people in the area, including the coal miner and his family. His nuclear family was spared, he says, but "most of the people I knew were killed."
At the time, he says he had no direction and was fighting in the streets. Mr. Li says his grandmother, who was among the first women in her city to attend college, inspired him to begin reading and studying. He later attended Nanjing University, majoring in physics.
In April 1989, he traveled to Tiananmen Square in Beijing to meet with students who were gathering to mourn the death of Secretary General Hu Yaobang, who was viewed as a supporter of democracy and reforms.
The students protested against corruption, among other things, and Mr. Li helped organize the students and participated in a hunger strike.
He and other students fled to France. Later in 1989, he traveled to the U.S. to speak at Columbia University, where human-rights activists embraced him as a hero. He spoke little English but landed an advance to write a book about his experiences.
Helped by financial scholarships at Columbia, Mr. Li quickly learned English. He simultaneously earned three degrees: an economics degree, a law degree and a graduate degree in business, according to Columbia.
With his student loans piling up, Mr. Li attended a lecture by Mr. Buffett at Columbia in 1993. At the time, the 1990s bull market was in full swing, and hedge funds were on the rise. Mr. Li says in China he didn't trust financial markets but hearing Mr. Buffett helped him overcome skepticism about stock investing.
He began dabbling in stocks using money from his book advance. By his graduation in 1996, he had built a sizable nest egg and says he thought he could retire. Instead he took a job at securities firm Donaldson Lufkin & Jenrette and then left to set up his own hedge fund. In 1997, he had set up Himalaya Partners, a hedge fund. Later he started a venture-capital fund to invest in U.S. technology companies.
It was a heady time on Wall Street. The Internet boom was beginning. Investors were clamoring to find hot stocks.
Through his human-rights contacts, Mr. Li quickly attracted well-heeled clients including Bob Bernstein, former chairman of Random House and founder of Human Rights Watch as well as the musician Sting. Other investors included financier Jerome Kohlberg, News Corp. director emeritus and Allen & Co. executive Stanley Shuman and hedge fund manager Jack Nash, Mr. Li says.
But Mr. Li bombed out in 1998, his first year as a hedge fund manager. His fund, which was invested chiefly in Asian stocks, was hammered by the Asian debt crisis, and lost 19%.
"I felt bad that people had trusted me," he says. "All they knew was I was a student activist and all they saw was losses."
His fortunes rebounded as the Asian crisis quickly faded. As 1998 began, so did a huge new bull market. By now, the hedge-fund industry was growing gangbusters, and by the end of 1999, Mr. Li's fund had regained its losses.
In 2002, hedge-fund giant Julian Robertson gave Mr. Li money to invest in his fund on the condition that the fund would make bearish as well as bullish bets on companies.
It wasn't a good fit. Mr. Li says he "hated" betting against stocks, complaining that he had to "trade all the time" to adjust his portfolio. (The remaining parts of the fund now are being unwound.) Mr. Robertson declined to comment on the business relationship.
One of Mr. Li's human-rights contacts was Jane Olson, the wife of Ronald Olson, a Berkshire director and early partner at a Los Angeles law firm Mr. Munger helped found. Mr. Li began spending time at the Olsons' weekend home in Santa Barbara, Calif., and on Thanksgiving 2003 met Mr. Munger, whose home is nearby.
Mr. Munger says Mr. Li made an immediate impression. The two shared a "suspicion of reported earnings of finance companies," Mr. Munger says. "We don't like the bull—."
Mr. Munger gave Mr. Li some of his family's nest egg to invest to open a "value" fund betting on beaten-down stocks.
Two weeks later, Mr. Li says he met again with Mr. Munger to make certain he had heard right. In early 2004, Mr. Li opened a fund, putting in $4 million of his own money and raising an additional $50 million from other investors. Mr. Munger's family put in $50 million, followed by another $38 million. Part of Mr. Li's agreement with Mr. Munger was that the fund would be closed to new investors.
Mr. Li's big hit began in 2002 when he first invested in BYD, then a fledgling Chinese battery company. Its founder came from humble beginnings and started the company in 1995 with $300,000 of borrowed money.
Mr. Li made an initial investment in BYD soon after its initial public offering on the Hong Kong stock exchange. (BYD trades in the U.S. on the Pink Sheets and was recently quoted at $6.90 a share.)
When he opened the fund, he loaded up again on BYD shares, eventually investing a significant share of the $150 million fund with Mr. Munger in BYD, which already was growing quickly and had bought a bankrupt Chinese automaker. "He bought a little early and more later when the stock fell, which is his nature," Mr. Munger says.
In 2008, Mr. Munger persuaded Mr. Sokol to investigate BYD for Berkshire as well. Mr. Sokol went to China and when he returned, he and Mr. Munger convinced Mr. Buffett to load up on BYD. In September, Berkshire invested $230 million in BYD for a 10% stake in the company.
BYD's business has been on fire. It now has close to one-third of the global market for lithium-ion batteries, used in cell phones. Its bigger plans involve the electric and hybrid-vehicle business.
The test for BYD, one of the largest Chinese car makers, will be whether it can deliver on plans to develop the most effective lithium battery on the market that could become an even bigger source of power in the future. Even more promising is the potential to use the lithium battery to store power from other energy sources like solar and wind.
Says Mr. Munger: "The big lithium battery is a game-changer."
BYD is a big roll of the dice for Mr. Li. He is an informal adviser to the company and owns about 2.5% of the company.
Mr. Li's fund's $40 million investment in BYD is now worth about $400 million. Berkshire's $230 million investment in 2008 now is worth about $1.5 billion. Messrs. Buffett, Munger, Sokol, Li and Microsoft founder and Berkshire Director Bill Gates plan to visit China and BYD in September.
Mr. Li is able to travel in China on a limited basis today, but he hopes to regain full travel privileges soon. It isn't clear how he is viewed by the Chinese government.
Mr. Li declined to name his fund's other holdings. Despite this year's losses, the $600 million fund is up 338% since its late 2004 launch, an annualized return of around 30%, compared to less than 1% for the S&P 500 index.
Mr. Li told investors he took a lesson from watching the World Cup, comparing his investment style to soccer. "You may very well work extremely hard and seldom score," he says. "But occasionally—very occasionally—you get one or two great chances and you make decisive strikes that really matter."
The following is a translation by Enoch(http://blog.enochko.com/2010/06/my-teacher-charlie-munger-english.html) on Li's foreword of his translation to Chinese of Poor Charlie’s Almanack.
【"China Entrepreneur" Magazine】Twenty years ago, as a young student coming to the United States, I couldn’t have imagined having a career in investments and would never have thought that I’d be fortunate enough to meet with the contemporary investment guru, Mr. Charlie Munger. In 2004, Mr. Munger became my investment partner and has since become my lifelong mentor and friend -- an opportunity I would have never dared to dream about.
I graduated from Columbia University in 1996 and founded my investment company in 1997, thus starting my professional investment career. Till this day, the vast majority of individual investors and institutional investors still follow investment philosophies that are based on "bad theories." For example, they believe in the efficient market hypothesis, and therefore believe that the volatility of stock prices is equivalent to real risk, and they place a strong emphasis on volatility when they judge your performance. In my view, the biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. Not only is the mere drop in stock prices not risk, but it is an opportunity. Where else do you look for cheap stocks? But I found that while, on the surface, famous fund managers appear to accept the theories of Buffett and Munger and show great respect for their performance, they are in actual practice the exact opposite because their clients are also the exact opposite to Buffett and Munger. They still accept the theories that say "volatility is risk" and "the market is always right."
A serendipitous opportunity led me to meet my lifelong mentor and friend, Mr. Charlie Munger.
Charlie and I first met at a mutual friend’s house while I was working on investments in LA after graduating from college. The first impression he gave me was “distant” -- he often appeared to be absent-minded to the presence of his conversation partners and was, instead, very focused on his own topics. But this old man spoke succinctly; his words full of wisdom for you to mull over.
Seven years after we’ve known each other, at a Thanksgiving gathering in 2003, we had a long heart-to-heart conversation. I introduced every single company I have invested in, or researched, or am interested in to Charlie and he commented on each one of them. I also asked for his advice on the problems I’ve encountered. Towards the end, he told me that the problems I’ve encountered were practically all the problems of Wall Street. The problem is with the way the Wall Street thinks. Even though Berkshire Hathaway has been such a success, there isn’t any company on Wall Street that truly imitates it. If I continue on this path, my worries will never be eliminated. But if I was willing to give up this path right then, to take a path different from Wall Street, he was willing to invest. This really flattered me.
With Charlie’s help, I completely reorganized the company I founded. The structure was changed into that of the early investment partnerships of Buffett and Munger (note: Buffett and Munger each had partnerships to manage their own investment portfolios) and all the shortcomings of the typical hedge funds were eliminated. Investors who stayed made long-term investment guarantees and we no longer accepted new investors.
Thus I entered another golden period in my investment career. I was no longer restricted by the various limitations of Wall Street. The numbers still fluctuate as before, but eventual result is substantial growth. From the fourth quarter of 2004 to the end of 2009, the new fund returned an annual compound growth rate of 36% after deducting operating costs. From the inception of the fund in January 1998, the fund returned an annual compound growth rate in excess of 29%. In 12 years, the capital grew more than 20 folds.
Buffett said that, despite the countless people he has met in his life, he has never encountered anyone else like Charlie. And in the years that I’ve known Charlie, and was fortunate to be able to intimately understand him, I am also deeply convinced that. Even from all the biographies of people from all ages, I have yet to see anyone similar to him. Charlie is such a unique man -- his uniqueness is in his thinking and, also, in his personality.
When Charlie thinks about things, he starts by inverting. To understand how to be happy in life, Charlie will study how to make life miserable; to examine how business become big and strong, Charlie first studies how businesses decline and die; most people care more about how to succeed in the stock market, Charlie is most concerned about why most have failed in the stock market. His way of thinking comes from the saying in the farmer’s philosophy: I want to know is where I’m going to die, so I will never go there.
Charlie constantly collects and researches the notable failures in each and every type of people, business, government, and academia, and arranges the causes of failures into a decision-making checklist for making the right decisions. Because of this, he has avoided major mistakes in his decision making in his life and in his career. The importance of this on the performance of Buffett and Berkshire Hathaway over the past 50 years cannot be emphasized enough.
Charlie's mind is original and creative, never subject to any restrictions, shackles, or dogmas. He has the curiosity of children and possesses the qualities of a top-notch scientists and their scientific research methods. He has a strong thirst for knowledge throughout his life and is interested in practically all areas. To him, with the right approach, any problem can be understood through self-study, building innovations on the foundation laid by those who came earlier. His thinking radiates out to every corner of business, life, and [areas of] knowledge. In his view, everything in the universe is an interactive whole, and all of human knowledge are just pieces to the study of the comprehensive whole. Only by combining of these knowledge through a latticework of mental models can they become useful in decision-making and in developing the proper understanding of things. So he advocates studying all the truly important theories in all disciplines, and building on this foundation the so-called “worldly wisdom” as a tool for studying the important issues in business and investments.
Charlie’s way of thinking is based on being honest about knowledge. He believes that in this complex and changing world, there will always be limitations to human cognition and understanding, so you must use all the tools at your disposal. And, at the same time, you must constantly collect new verifiable evidences, correcting and updating your knowledge, and knowing what you know and what you don’t know.
But even so, the true insights a person can get in life is still very limited, so correct decision-making must necessarily be confined to your "circle of competence". A “competence” that has no defined borders cannot be called a true competence. How do you define your own circle of competence? Charlie said, if I want to hold a view, if I cannot refute or disprove this view better than the smartest, most capable, most qualified person on Earth, then I’m not worthy of holding that view. So when Charlie truly holds a certain point of view, his thinking is not only original and unique, but also almost never wrong.
A beautiful lady once insisted that Charlie use one word to sum up the source of his success, Charlie said it was being “rational.” However, he has a more stringent definition of rationality. It is this kind of “rationality” that grants him the sensitive and unique vision and insight. Even in a completely unfamiliar territory, with just one look he could see through to the essence of things. Buffett calls this characteristic of Charlie the “two-minute effect” -- he said Charlie can, in the shortest time possible, unravel the nature of a complex business and understand it better than anyone else can. The process of Berkshire’s investment in BYD Auto is an example. I remember in 2003, when I first discussed about BYD with Charlie, despite having never met Wang Chuanfu (Chairman of BYD Auto), visited BYD’s factory, and being relatively unfamiliar with the Chinese market and culture, his questions and comments about BYD remains, till this day, the most pertinent questions a BYD investor need to ask.
Everyone has blind spots, and even the brightest people are no exceptions. Buffett said: “Benjamin Graham taught me to only buy cheap stocks, Charlie allowed me to change my thinking. That’s the real impact Charlie had on me. I needed a powerful force to walk out of the limitations imposed by Graham’s theories. Charlie’s ideas were that source of power -- he expanded my horizons.” I’ve also had this profound experience. Charlie pointed out the blind spots in my thinking; if it weren’t for his help, I’ll still be still in process of evolution, slowly crawling along.
Charlie spent a lifetime studying disastrous human mistakes and is particularly fond of catastrophic errors caused by human psychological tendencies. The most valuable contribution is that he predicted the disastrous consequence of the spread of financial derivatives and the loopholes in the accounting and auditing system. Back in the late 1990s, he and Mr. Buffett already raised the disastrous potentials of financial derivative products. They escalated their warnings with the proliferation of financial derivative products, calling financial derivative products finance-based weapons of mass destruction; if they were not stopped in a timely and effective manner, they would have a devastating impact on the modern society. The financial tsunami and global economic recession in 2008 and 2009 unfortunately validated Charlie’s far reaching vision and insights.
Compared with Buffett, Charlie has a far wider range of interests. For instance, he has strong interests and has done extensive studies in almost all fields of sciences and social sciences, integrating them to form the original and unique Munger ideology. Compared to anything coming from within the ivory towers’ system of thinking, Munger’s doctrines are built to solve practical problems. For example, as far as I know, Charlie was the first to propose and systematically study human psychological tendencies and its huge impact on decision-making processes in investments and business. Now, tens of years later, behavioral finance has become a popular area of research in economics, with behavioral economics winning the recognition of the Nobel Prize. The theoretical framework Charlie describes in the final chapter of this book, “the Psychology of Human Misjudgment," may become more widely understood and applied by people in the future.
Charlie is naturally full of energy. Charlie was 72 years old when I first met him in 1996. He is 86 years old this year. In the tens of years I’ve known Charlie, his level of energy has never changed. He is always energetic and is an early riser. Breakfast meetings always begin at 7:30 am. At the same time, because of dinner events, his spends less time sleeping than the average people, but that does not affect his exuberant energy. His memory is also amazing. He still remembers BYD's operating figures I discussed with him many years ago while my memories have already blurred.
The 86-year-old man has a better memory than this young man. These are his innate advantages, but he acquired through hard work the unusual qualities that contributed to his success. Once Charlie found one thing he wants to do, he can do it for a lifetime.
To me, Charlie is not just a partner, he is also an elder, a teacher, a friend, a role model for success and a role model in life. Not only did I learn from him the principles of value investing, I also learned from him how to live life. He made me understand that a person's success is not accidental. Timing and opportunities are, of course, important, but the inherent qualities of people are even more important.
Charlie likes to meet people for breakfasts, usually starting at 7:30 am. I remember the first time I had breakfast with Charlie, I arrived on time, only to find Charlie sitting there, finished with the day’s newspapers. While it was only a few short minutes away from the 7:30, but I felt bad letting an elderly man I respected wait for me. For our second date, I arrived about fifteen minutes earlier and still found Charlie sitting there, reading the newspaper. For our third meeting, I arrived half an hour earlier and Charlie was still reading the newspaper, as if he had been waiting there all year round and had never left the seat. For the fourth meeting, when I arrived an hour early at sat there to begin waiting at 6:30 am, and at 6:45 am, Charlie leisurely walked in with a pile of newspapers and sat down, not even looking up, completely unaware of my existence. Afterwards, I came to understand that Charlie will always be arrive early for meetings. But he doesn’t waste time either, he will take out the newspaper he prepared to read.
In my interactions with Charlie, there was another thing that made a big impact on me. One year, Charlie and I were attending an out-of-state meeting. After the event, I was hurrying to get back to New York and unexpectedly met Charlie at the airport terminal. When his huge body passed through the security detector, for some unknown reason the detector kept being set off. Charlie returned to again and again for the security check. He finally passed through the security checkpoint after a long and laborious effort, but, by then, his plane had already departed.
But Charlie was not in a hurry. He took out a book he carried with him and sat down to read while he waited for the next plane. Incidentally, my flight was also delayed so we waited for our flights together.
I asked Charlie: “You have your own private jet and so does Berkshire, why do you bother going through the trouble of flying commercial?”
Charlie replied:”Firstly, it is a waste of fuel for me to fly in my private jet. Secondly, I feel safer flying in a commercial aircraft.” However, the real reason is Charlie’s third reason, “I want to live an engaged life. I don’t want to be isolated.”
What Charlie can’t tolerate is to lose contact with the world because of money and wealth. To isolate yourself in a single room behind a labyrinth of offices, to require layers after layers of approvals to setup meetings, and to hide behind a complicated bureaucracy so you become hard to reach for anyone - that is how you lose touch with the realities of life.
"As long as I have a book in my hand, I don’t feel like I’m wasting time." Charlie always carries a book on him. Even if he’s sitting in the middle seat in economy class, as long as he has a book, he’ll have no complaint. Once he went to Seattle to attend a board meeting, taking the economy class as usual, he sat beside a Chinese girl who was doing her calculus homework throughout the flight. He was impressed with this Chinese girl because he has difficulty imagining American girls of the same age having such power of concentration to ignore noise on the aircraft and concentrate on studying. If he was aboard a private jet, he would have never had the opportunity to come into close contact with these stories of ordinary people.
Though Charlie has very strict self-discipline, he is very generous with others and treat people he cares and love really well. He is not stingy with money, always hoping others will benefit more. For his own travels, whether for business trips or for personal trips, he always flies economy class, but when traveling with his wife and family, he would take his own private jet. He explained: my wife brought up so many children in her lifetime and has given me so much. Now that her health isn’t as good as it used to be, I must take good care of her.
Charlie spent his lifetime studying the causes of human failures, so he has a profound understanding of the weaknesses of human nature. Because of this, he believes people must be strict and demanding on themselves, continuously improving their discipline in life in order to overcome the innate weaknesses of human nature. This way of life is, to Charlie, a moral requirement. To an outsider, Charlie might seem like a monk; but to Charlie, this process is both rational and pleasant and it allows people to having a successful and happy life.
Charlie is such a unique person. But if you think about it, if Munger and Buffett weren’t so so unique, how could they have built Berkshire’s performance over 50 years into one that is unprecedented in the history of investments and one that has yet to be replicated.
Over the years I’ve known Charlie, I often forget that he is an American. He is closer to being the traditional Literati (scholar-officials) of Imperial China that I knew.
After the Imperial examination system ended, over the past hundreds of years, the spirit of the Literati has been lost to reality. Especially in the highly developed commercial society of this time and age, the Chinese scholars who bear the spirit of the Chinese Literati are often confused about the value and ideals of their own existence. In a commercial society where tradition has been lost, is the spirit of Literati still applicable or useful? In the late Ming Dynasty, capitalism began to sprout in China, the merchants at that time raised the ideals of "a business person with a Literati’s soul.” Today, the forces of the commercial market has become the dominant power, and I think there are more possibilities for this ideal to become a reality.
Charlie can be said to be the best example of "a businessman with a Literati’s soul". First of all, Charlie is extremely successful in business. However, in the deep intimate interactions I’ve had with Charlie, I found Charlie to be essentially a moral philosopher and a scholar. He reads widely, is knowledgeable over a broad range of topics, is truly concerned about his own moral cultivation, and is ultimately concerned about the society. Charlie's value system, from the inside out, promotes self-cultivation and self-development to become the “saints” who help others.
After achieving business success and wealth, Charlie is still committed to charity and to benefiting the people of the world. He was complete dependent on his wisdom in achieving his success, and this is undoubtedly an exciting role model for Chinese scholars. He made full use of his own wisdom and achieved great success in business with the utmost integrity. Today, in the market economy, can the Chinese scholars be filled with the spirit of the Literati and, by improving themselves through learning and self-cultivation, achieve the successes of the secular society while realizing the value of their own ideals?
Charlie very much appreciates Confucius. I sometimes think that if Confucius was reborn in America today, Charlie will probably be the best incarnation. If Confucius returned 2000 years later to the commercialized China, his teaching will probably be: have your heart in the right place, cultivate your moral character, fortify your family, acquire wealth, and help the world!
(This article was written for the foreword to "Poor Charlie's Almanack - The Wit and Wisdom of Charles T. Munger” - published in May 2010, some paragraphs were cut, the title was added by the editor.)
[Translator’s notes: Thanks to Ee Lin Sim for her assistance in translation. Please send feedbacks to Enoch Ko: contact (at) enochko [dot] com]