Deja vu all over again.

So it seems that the whole market slump/credit crisis/investing fruforall we’re having is only getting worse.  It’s getting so that I’m wondering seriously about the money in my 401 (k).  I mean, everything across the board almost is losing money – how am I supposed to protect an investment I can’t really touch?  Are bonds or anything at all doing well? I mean, I was seriously surprised that Bear Stearns collapsed in on itself and is no longer worth the value of the building where it’s located.  I mean, how often does a major company go from a multi-billion dollar value to just over 300 million dollars over the weekend?  I may not know alot about the whole investment thing, but I don’t think that can happen very often.  I mean, isn’t that basically the kind of thing that caused the Great Depression?

And where’s our New Deal?  The bottom keeps dropping out, and even though the government fuses money back in, nothing seems to be getting better.  It doesn’t give me a surfeit of trust in the government’s financial strategy.  The whole thing reminds me of  Fight Club (the movie – I never read the book) and the idea that the world would somehow devolve with the destruction of credit records.  I mean, look at us.  Here we are, all worried about this market fluctuation, and yet.  And yet we go about our daily lives and it doesn’t really impact us.  And yet we keep eating and don’t think much about where the next meal is coming from.  And yet most of us seem to still be able to buy the things we need.

Why is that?  It may be true that those who are trying to get a mortgage may find it harder.  It also may be true that we expect to save money in order to have a leisurely retirement.   But these are not things we need, per se.  These are not things that really affect us on a daily basis.  We can ignore them, at least for awhile.  And although to do so on a regular basis would be considered ill-thought in the modern adult world, I wonder if we let them be if our lives would become more filled with something better.

The Lion and the Big Orange Ball

While the title may seem like a great one for a children’s story, I really want to talk about something more serious and adult.  So, the adventures of Sparky and his amusing attempts to defeat inflated rubber in mortal combat will have to wait.  Instead, I’m going to discuss online banking and investing, one of the most serious and adult topics I can think of.

Currently, I have three actual bank accounts.  Two of them (checking accounts) are due to the logistics of my past – Indianapolis has eliminated Bank of America (woohoo!) and therefore there are no banks that have branches both in Indy and Boston.  When I moved to Boston, I opened my second account, but I still have the Indy one, just in case.  I think it has about $30 in it.  The final account is a savings account with ING direct.

For those of you who don’t know about ING Direct (and especially don’t have an account yet), let me give some detail.  It’s pretty awesome.  They give really good rates, probably because of lower overhead.  They have no branches – all transactions are handled online, so no locations to maintain, service people to hire, or paper transactions to record.   And if  you want to do CDs or other higher-yield savings options, they have those too.  Money is easily transferable, though sometimes the transaction does take a few days to process.  Also, if you let me refer you, I think I can get you $25 for your account, and me $10.

They have also just acquired Share Builder, which is basically an online investing platform.  So, now you can trade stocks and ETFs with them daily as well.  The associated fees are comparable to something like Scottrade, about $10 per transaction, which is twice as much as cheaper options like Zecco.  However, since I know them and they’ve proven so reliable with my money in the past, I think I might try it out.

Hedging

In English parlance, ‘hedging’ typically refers to statements made to qualify or modify a more extreme position or opinion. Hedging in the financial or investment sense is pretty much the same thing (i.e., covering your butt) but the way in which it occurs is what’s confusing.

So I’ll go over the simple part first. So, you want to invest. Maybe it’s in a stock, or even in a group of stocks, that you think will rise in price. Pretty simple, right? But, what if the market does poorly? What if there’s a universal market crash? How do you protect that investment? The answer is a hedge. A hedge is an investment you make as a protection against risk. Wikipedia has a really good example of how the actual investment might look and perform over a few days, so I won’t bother to re-describe that here. What I will mention is a bit about how the complexity of a hedge works.

A hedge is typically a ‘shorting’ of a stock, meaning a contract for the rights to stock shares in the short term. It could be a swap, an option, or a future, or some other kind of right, but it is often not the actual physical exchange of stocks. Let’s look at an example. You think F industry, of which B stock is a part, is going to do poorly. Or you just think B stock is going to do not-so-well. You would take a short position of this stock, borrowing the stock and selling it at its current market price. Then, at a predetermined or optional future date, you buy the shares back, hopefully at a lower price, and return them to the lender. If the shares of stock actually fell in value, you’ve made a profit.

The question then comes up as to what the lender of the short has gained. Probably there was some sort of money exchanged for the rights to the stock for that period of time, either a percentage or some other exchange. I’m not sure exactly how that technically works yet. Also, I’m not sure I need to. Right now I’m going to go ‘hedge my bets’ that I don’t need to know.

A bit of swap, a dabble of ETF

Due to some recent stuff going on at work, I’ve been learning a little bit more about some non-traditional types of investments – index traded funds, ETFs, options, futures, and swaps. Since I’m getting the knowledge (and knowledge is power?), I thought I’d pass it all along to you.

Most of what I know is involved with the differences between these types of funds, but I will try to give a short summary, and end with why you might care – especially if you are looking to invest a bit yourself.

Let’s start with options first. Stock options are exactly what they sound like – they are a contract giving the right, within a certain period, to buy or sell a specific number of shares of a specific stock. However, there is no obligation to buy/sell at all, and the contract can be fulfilled at any time during the agreed-upon period. There’s a formula for calculating whether or not the option risk is worth it, but I don’t really understand how this works. There are also exchange-traded options which are options on a range of funds, mimicking an ETF.

So – futures.  Basically, they’re the same as options, except you make an agreement to trade stock (or a group of stocks) on a certain day.  There’s no backing out or choosing which day to trade.   You’re making a best-guess as to what will be happening in the future market, and through this prediction and the associated risk analysis, you’re speculating that one stock or group of stocks will do well.  There’s more to it having to do with marking-to-market, which I don’t really understand, but hopefully I will sometime soon.  At the moment, I really don’t know why people would buy futures, other as a sort of balance to risk in other areas (i.e., hedging) using the sale (or short) of the future to protect and counterbalance an investment in the same industry.  Forwards are a similar exchange that are traded between individuals rather than through an exchange, increasing risk for both parties, and they are not marked to the market daily, meaning that drastic market changes don’t get calculated until the end of the agreement.

Swaps are kinda like futures and options, but they are a little different – and I’m talking strictly about equity swaps here.  The key difference is that swaps, like forwards, are traded between individuals rather than on an exchange.  This means that there is less security for the parties involved.  Also, different brokers tend to offer extremely different swaps due to their own investments.  Maybe they are looking to offload a particular index for awhile either as a hedge for themselves or to manipulate their own portfolio in some way – then they’d be much more likely to swap the rate of that index at a deep discount.  Swaps usually deal with cash flows, rather than actual trading of stocks or indices – instead, they seem to refer to the pricing of an index and a comparative interest rate over a certain period.  Again, not really sure the advantage of one of these, unless you know things I don’t.

So, lastly, indexed funds and ETFs.  I’m lumping these together since they’re basically only different in their  tradablility.  ETFs can be traded throughout the day, where indexed funds use the closing price of the previous day.  basically they are groups of funds in a range of flavor, allowing you to invest in an index or across a broad spectrum of funds.  They are similar to a mutual fund, but more flexible and more liquid (and cheaper).  You don’t pay as many fees on them, but they are also not heavily managed.  If you want to invest in barrels of apples across the board, you’re getting the bad apples as well as the rest of the bunch.  However, if a specific commodity or area starts doing really well or really badly, you can get in and out of these types of funds fast.

To conclude – indexed funds and ETFs, yay!  They rock the personal investor, especially if you are espousing a specific area of investment.   The others, pretty much stay away, until you (or I) do a little more studying up on how to use them as balances and counters to other things you might want to do.

A New ‘Subprime’?

What with all the current investing hoopla about mortgages, ‘subprime’ has become a buzz word. Even Al Gore is jumping on the bandwagon – at a recent UN-sponsored event for investors and financial advisors, he used the word to describe investments which relied heavily on carbon use. The idea behind his speech relates to the spirit of capitalism-money is the means to effect change.

A similar pull was seen from the ground up in protests regarding investments that supported genocide in Darfur the past few years. Many school endowments were put under pressure to withdraw from investments which supported the regime. While this movement awoke people to the possibility of investment as a tool for change, it remains to be seen how much impact such change really imparted. I know at the Oven Glove, though a policy of not supporting genocide was put in place, very little of our invested money was withdrawn. Mostly we were already not investing in genocide, yay! But the overall result was to make me wonder how much impact happened in Darfur overall.

A part of what Al Gore is trying to do here is commendable. He’s going to the source. If the high-power investors themselves see a higher cost in investing in carbon now and dealing with the problems it causes later, they will make investment changes and many people will follow their lead. But again I wonder how much impact even high-power investment changes will have.  South American countries have always been between the rock and hard place of the US historical expansion model and current morals of rain forest preservation and rural protectionism. China, with its burgeoning industry and development, was notorious during the Darfur issue for not removing many of its investments from that area. With the need to modernize, can a growingly consumptive population giant like the PRC afford to ignore carbon? Should they have to?

More on the crazy credit front.

I’ve written a little bit about the current ‘credit crisis‘, but I came across this blog dedicated to stockpiling information about the whole thing as it happens.  If you’re interested in more gloom and doom, you should check it out.  Some timely advice might be that governmental classic from the Cold War era, ‘Duck and Cover‘.  For myself, I vastly prefer Samuel L. Jackson’s line in Jurassic Park: “Hold on to your butts.”

Out of India

A co-worker sent me this article on the recent loss of interwebbing in those countries that need it most.  Early (and therefore, questionable) reports indicate that entire continent’s internet links may have been severed by a boat anchor killing an undersea cable that could take 2 weeks to repair.  I ask you, a boat anchor?  Is technology really so frail?

Also, this may be something I just don’t get about the interweb and its high-tech structure, but how much impact should one cable between Egypt and Italy really have?  Should that really cut India’s bandwidth in half?  I get the whole idea of communications with certain areas or between certain areas being drastically reduced, but I would think they would have a few more backups or alternatives in place.   I mean, the UAE is worried about the whole thing crippling its ability to do business.  India as well, especially with all the customer service and other backups to businesses here that they provide.  It dosn’t really work without internet, and it could majorly affect international stocks in an interesting way the next few weeks. Not that anyone will be able to take advantage (unless they happen to be in these countries and can like walk to the trading floor).

We recently implemented a backup email system here at work, but what happens when the whole interweb fries up and blows away?  Do they shut down the stock market?  Sorry guys, no trades today!  Really, those Fight Clubbers should’ve just gone out and dredged the ocean floor rather than blowing things up.

My heart goes out to those lonely souls teaching and doing other service work abroad in those countries.  I remember well those days in China, when the interweb beckoned like the vision of some sort of Holy Grail.  Alas, it’s almost as bad as a power outage.  Good luck Judith!  Glad I’m not in Qatar or environs today.

More Noises about Private Equity and Debt.

So now it’s time for everyone’s favorite time of day again – that time when I try to sound intelligent and well-versed in all things investing. I was ‘reading some interesting information’ (aka doing my job and editing boring investment reports) when I started thinking about some stuff the common man might not know about private equity, and I thought I would share my thoughts with him.

First of all, private equity is all that investment action that you, the common man, can’t get in on. It involves trading of stocks not on the public market, usually involving company takeovers and large-scale investments that even the upper middle class will never be able to afford. So. Why do any of us really care, unless we become billionaires? Debt.

I’ve written a bit before about my own skewed view of the current debt and mortgage system, but private equity is a part of that system in a big big way. Basically, a private equity investment company works to develop existing or start-up companies and corporations.  This doesn’t always involve debt, or buying out an entire company, but it can.  A private equity company usually researches a particular market – say, software – with a specific target in mind. Let’s give an example. Let’s say Geronimo is an investment management company in the home appliance market that is targeting undervalued and underperforming companies. That means they look at all the cheapest private companies that make home appliances and try to figure out why those few companies are doing so badly. Then, if they think they can improve the company and generate some money from it, they buy it out, change it around, and sell it for a profit. Of course, sometimes it doesn’t work out like it’s supposed to. Even in a strong market, there could be so many companies that no amount of improvement in one is going to lead to large profits. Or, the market could take a sudden dip, leaving our sad Geronimo with no profit for all its hard work.

The buyout system usually works because the investment companies like Geronimo make enough in one investment to fund months of research and bargaining for another. Plus, once a company like this gets known for its successful work, it gets easier to make attractive buyout proposals to private companies.

The problems we’re facing right now due to a slumping economy increase pressures for private equity – there’s less of a guarantee that an investment will post significant gains. Research becomes even more important. In addition, since the majority of these takeover involve large infusions of capital, many of these private equity companies use debt to make the initial purchase. Which means, of course, if they don’t make good on their investment, they’re actually short of cash due to interest on those loans. Which means, in times of scarcity, the normal private equity players may be more reluctant to taake on a questionable investment, meaning that more corporations may be run inefficiently, which certainly doesn’t improve market conditions. One great big circle yet again. Yay!

Old Dog, New Tricks

    So, I thought I would write a little bit about how the big money-manager guys play the investment game, at both the more immediate manager level, and the more removed school endowment level.

First, the more immediate manager level.  These are the guys who work for mutual funds or other specific types of money managers.  They operate on one basic principle: knowledge = good investing.  Basically this means a particular mutual fund or other mixed organization of individual stocks has a specific, narrow investment area.  This could be one industry, or country or region, or one category of goods such as commodities or raw materials.  And these professionals know everything about that area.  They have strong contacts with a variety of professionals working at companies in that area.  They know the latest and greatest developments that are coming.  Most especially, they are watching the supply and demand chains for a variety of corporate entities related to their area.  Basically this broad spectrum of knowledge in a narrow part of the investment pie is supposed to help them make intelligent and informed decisions about what companies will do well and should be invested in by the larger portfolio.  Of course this sometimes breaks down – even the best, most informed guesses are not correct.

How this relates to you:  These are the same types of people you will be working with to manage your money, so this does give you a better sense of how they operate and why they can probably do a better job picking stocks than you can.  But how do you really tell the difference between one service provider and another?

On to the next topic: how endowments pick their money managers.  Basically, endowments have begun to follow the philosophy of judging their managers not on returns, which can be misleading, but on something less quantifiable – the way they think.   The idea here is that an intelligent and informed manager will make an advantageous investment decision 8 or 9 times out of 10.  In addition, the same philosophy of knowledge = good investing is used to pick managers.  Opinions are collected from other investment firms, previous co-workers and associates to individuals within the firms, and other investors in the firm.  Most importantly, face-to-face meetings are arranged so specific questions or issues can be addressed, and the general intelligence and knowledge of the group be evaluated.

How this relates to you: Obviously, the majority of the evaluation techniques are not open to the individual.  How then, if past performance is not always a valid indicator, can you choose one specific investment firm over another?   Key principles remain the same.  More knowledge means better investment judgment, and a certain amount can be discovered publicly.  Check out the key individuals in a firm – read articles about them.  There are tons and tons of publications about which industry or area should be invested in – check some of these out, and see how they compare to your own evaluation of current market conditions.  Absorb as much as possible in areas familiar and comfortable for you, and see where ti takes you.  Of course, investing in a range of industries is important, but if you know more about one area, that’s where your particular knowledge is going to give you an edge.  Don’t be afraid to use it by weighting your portfolio in that direction.

Debt, Mortgages, and How They Affect Your Life

There’s been tons of hoopla in the media recently about mortgages, especially high-risk mortgages that have been defaulting.  If you haven’t heard something in this vein, you’ve probably been living under a rock, deliberately avoiding current events.  Event though that’s what I normally do, I thought I should crawl out for a bit and echo the voice of doom.

Now, I’m sure most people are confused.  So a few poor people defaulted on their home loans.  What’s the big deal?  the banks foreclose, someone new gets the land and pays for it, everyone is happy.
In order to a clearer view, I need you to think back to your days of high school economics.  You know, supply, demand, all that good stuff.  I’m not sure if you recall, but somewhere in that course, you probably talked about how economic growth was judged – what the factors for positive growth were, and what factors were part of an economic downturn.  At that time in my life, the economy was fairly stable, as judged by two key factors – unemployment, and building.  Characteristically in this economy, people stay employed if it is worthwhile to them – if it is more cost effective to go to work for a wage than to stay at home and collect unemployment.  In a healthy economy, 3% should be the rate of unemployment.  It makes sense – if a small number of people are unemployed, more people are making a better wage, and are hence able to buy more things, growing the economy.  The building market works in much the same way – when people have more money, they are more willing to invest in a house, hence more housing is needed, hence more building occurs, creating more jobs and shooting money back into the economy in a widening cycle.

For the past several years, this has largely been the apparent cycle – better wages = stronger economy= more building = stronger economy.  The problem comes with speculation.   It’s almost become a part of the American dream to own a house – a good job, a good family, a home and two cars.  And with the housing market booming, everyone wanted some of the action.  People looking to expand their portfolio invested in real estate and housing instead of more traditional investment.  With the building boom, most property values were expected to increase as a demand for land grew.  In addition, to sate the American dream of those with lower credit ratings and lower incomes, mortgage lenders took on increasingly risky prospects.  Bad idea.

Basically, the rules that were developed to see if a person qualifies for a mortgage were put in place for a reason – to sort out those who could actually pay for a house over the long term.  While it’s true that the rules currently in place may be discriminatory, biased, and unfair,  that does not mean that everyone should be able to buy a house.  It’s not necessary for happiness, and I’m not sure it should be a part of what we see in our future.

But that’s all water under the bridge now.  The point is, how does this affect you?   Remember the high school economics?  Basically, enough big lenders and banks have invested in poor mortgages that it affects everyone.  When these lenders start posting downturns, it affects the market.  building slows – the market slows.  The value of housing and real estate goes down as the demand for it lessens.  Those with mortgages continue to pay the same monthly rate while the overall property value they are invested in decreases.  With jobs in the building industry falling off and banking institutions cutting costs in staffing, unemployment rises.  The market goes into a downturn.

What can you do?   Avoid debt, if possible.  Interest is going to be high, and creditors unsympathetic if you default.  If you have property investments and can afford to hold on to them, do so.  It may be a long ride, but eventually, property values should increase again.  Don’t be afraid to spend, but don’t feel forced to either.  Economists and other market watchers are asking for continued spending to help boost the economy.  There’s nothing wrong with that, and with the deflated spending pattern, you’re likely to get the goods you want at a bargain price.  Still, it’s also a good time to invest, with stocks priced low and interest rates high.  Basically, we could end up with a continued and lengthening downturn, but it shouldn’t get to the point of another Great Depression, or force us to starve.  So I’m pretty content with that.

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