It may be cheap, but is it a Goode value?
Guess who plays the lottery disproportionately? Poor people. Guess who buys the riskiest stocks with the lowest returns (particularly penny stocks)? Also poor people. Interesting academic paper here (pdf). People are also more likely to purchase volatile penny stocks in an economic downturn.
It is actually not uncommon for experts to be completely wrong and to make very dumb mistakes. A case in point comes with the charts of house prices relative to trends shown at Portfolio.com, taken from a presentation by Chris Mayer (who recently wrote an op-ed in the WSJ in favor of subsidized mortgage rates).
The problems with the charts shown are three-fold. I cannot tell if the charts show prices for the same houses (the Case-Shiller index tracks resales of houses to ensure that the prices are apples-to-apples, rather than the OFHEO index, which uses averages of all houses sold over a time period). The graphs say that both OFHEO and Case-Shiller data were used, which makes little sense. Averaging the two data sets would be meaningless. The price data are inflation-adjusted, however.
The second and third problems with the charts are that they show an exponential growth rate for the average house price. This assumes (incorrectly and absurdly) that house prices should increase at increasing rates over time. Furthermore, data (and logic) show that if house prices increase in inflation-adjusted terms at all, it is at a low, constant rate (excluding booms and busts) of maybe 1% per year. Even worse, by using an exponential curve to fit the house price trend, the trend line is unduly influenced by the recent bubble prices (exponential curve fitting is a very bad idea when there is a risk of outliers at the end of a curve; straight line curve fitting is much less susceptible to outliers). So in layman’s terms, by using an exponential curve for the trendline of house price change over time Chris Mayer assumed that the recent bubble prices were good estimations of the true value of housing, an absurd assumption.
While I could demolish Mayer’s arguments in favor of subsidized mortgages, I will leave that for another day.
Not one of the hedge funds of funds or banks that steered investors to Bernie Madoff’s funds has admitted their idiocy in failing to spot huge red flags. They have all tried to blame the SEC and other regulators. While the regulators failed spectacularly, even a successful effort on the part of regulators could not have stopped Madoff before he had harmed many investors. That was the case with Enron, with Bre-X, with US Windfarming, and with every penny-ante Ponzi scheme. A regulatory authority cannot act until a crime has been committed, and because of the need to prove a crime, there is little chance of stopping frauds when they begin.
On the other hand, investors (particularly funds of funds and banks, which have the skills and money to conduct thorough due diligence) only need to suspect that something is not right to choose not to invest and avoid losing money to a fraud. That is why I chose not to invest with US Windfarming (even though at the time I knew nothing about investing). If the large investors had done even a modicum of due diligence they would have seen the red flags such as the size of Madoff’s auditor and his insanely consistent returns.
Some commentators have argued that the Madoff scandal will harm hedge funds. That is likely, but the effect will be much greater on funds of funds. If an annual fee of 1.5% of assets under management does not mean that a FOF will perform basic due diligence, then FOFs are doomed. Even in the best of circumstances there is little point to FOFs. I predict that the number of funds of funds and their assets under management will shrink by over 80% in the next couple years. The world will be a better place as a result.
Maxlife Fund Corp (OTC BB: MXFD) filed its 10K today. There were no surprises. Maxlife has not had any revenue for the last year (the only revenue reported in its 10k is from the quarter ended November 30, 2007). Maxlife has sold $480,000 more in preferred shares in the most recent quarter. However, while the funds from the preferred shares are supposed to go to fund Maxlife’s joint venture with GGP, the funds are needed by Maxlife simply to fund its operating losses (net loss of over $300,000 in the most recent quarter).
I am surprised that Maxlife Fund Corp was able to sell as many preferred shares as it has, considering that for just about the same yield an investor could acquire the listed, unsubordinated debt of Comcast (CCW: $22.58 0.00%, market cap: $N/A), which is a far larger and more stable company (or one of a number of other preferred stocks or bonds). Perhaps Maxlife’s salesmen are good or perhaps their investors are just idiots. But there are many far safer bonds and preferred stocks yielding 10% or more; there is no need for an investor to buy unlisted preferred stock in an OTC BB company. I doubt Maxlife will be able to sell enough preferred shares to give it enough capital to actually function as a real business.
As to Maxlife’s much-hyped joint venture with GGP, that was supposed to buy/sell $1 billion face value of life insurance policies this year, it appears that it has made no money and Maxlife has not invested more than $1250 in it (see the 10K for details). Maxlife accounts for the JV with the equity method, which means that the profits or losses of the JV show up in Maxlife’s balance sheet as increases or decreases in the book value of its investment in the JV. (From the 10K: “The Company accounts for its non-controlling interests in joint ventures where the Company has influence over financial and operational matters, generally 50% or less ownership interest, under the equity method of accounting. In such cases, the Company’s original investments are recorded at cost and adjusted for its share of earnings, losses and distributions.”) Because in this most recent 10k the book value of the investment remained at $1250, I infer that the JV has not had material losses or profits.
Returning to the preferred stock sales, I should add that with every six shares of preferred stock come three free warrants. Considering these warrants are out of the money and I believe Maxlife to have a fair value of zero, I do not think a prudent investor should consider these in deciding to invest in Maxlife’s preferred stock. From the 10k:
The preferred stock of the Company are currently offered in units (the “Unit”). Each Unit consists of 1,200 shares of preferred stock plus warrants to purchase 600 shares of common stock. The warrants may be exercised at any time beginning six months from the date of issuance and ending on the fifth anniversary of the final closing of the offering of the preferred stock. The warrants are exercisable, in whole or in part, at exercise prices equal to the following:
One third (1/3) or 200 warrants per Unit shall be exercisable into common stock at $25.00 per share;
One third (1/3) or 200 warrants per Unit shall be exercisable into common stock at $30.00 per share;
One third (1/3) or 200 warrants per Unit shall be exercisable into common stock at $35.00 per share.
Disclosure: No position in MXFD. I am long CCW. I have a disclosure policy.
Okay, maybe it is not the bottom, but I am willing to bet that junk bonds will offer a good return on investment for those who invest now. At current yields, over 20% of the companies in a junk bond portfolio would have to go bankrupt for the portfolio to lose money. Large investors of course should pick and choose, avoiding bonds issued by private-equity backed companies. For smaller investors, the JNK ETF may be worth considering. It currently has a 19.99% SEC yield. The NAV at yesterday’s close was $27.22. I may buy a small bit of JNK in the near future.
Disclosure: No positions.
PILE the forclosures high in Las Vegas and Bakersfield.
Shovel them under and let me work—
I am the deleveraging; I cover all.
And pile them high in Phoenix
And pile them high in Detroit and DC.
Shovel them under and let me work.
Two years, ten years, and people ask their friends:
What place is this?
Where are we?
I am deleveraging.
Let me work.
—
The Banker does what bankers can,
Deeds quite impossible for Man,
But for one prize he shall always yearn,
The Banker has no ability to learn:
Among his grand earthly things,
the emptiness of his soul now stings,
The Banker stalks one last deal,
as in pain around him we all now reel.
—
COME play with me;
Why should you run
Through the empty streets
As though I’d a gun
To strike you dead?
Oh I’m just a taxpayer
and you’re a bailed-out banker
Run fast or die!
Employees at some of the following institutions have been reading my blog in November. In parentheses is the number of visits (not hits) from each.
CIBC World Markets (26)
Raiffesen Pension Fund Management (20)
Stifel Nicolaus (9)
Visual Trading Systems LLC (9)
Google Inc (5)
JP Morgan (5)
Wachovia (3)
Singapore General Hospital (3)
Deutche Bank (3)
Forbes (2)
Morgan Stanley (2)
In November I had visitors from 68 countries and every state in the US except for Alaska.