Wednesday, November 28, 2012

Newman, The Secret Financial Life of Food

Although Kara Newman’s The Secret Financial Life of Food: From Commodities Markets to Supermarkets (Columbia University Press, 2013) has an enticing title, it doesn’t divulge any secrets. Instead, it is a rather jagged history of U.S. agricultural futures markets. Each chapter focuses on a particular commodity or group of commodities: corn; grains; butter and eggs; coffee, sugar, and cocoa; cattle; pork bellies; produce such as apples, onions, potatoes, tomatoes, and orange juice; and soybeans. At the end of each chapter is a brief section entitled “What Trades Now” with a snapshot of the commodity’s use, what exchange it trades on, and its contract size.

Newman’s book includes a series of vignettes, replete with larger than life, sometimes shady characters. Take, for instance, “Tino” De Angelis, who was “the brains behind the Great Salad Oil Swindle [of the early 1960s], which ultimately bankrupted twenty banks and commodities and securities firms, including an American Express unit, and caused losses in the hundreds of millions of dollars.” (p. 146) Or Peter McGeoch, the lord of lard, who, following the crash of the lard market, shot himself. Or Jack Richard Simplot, the Idaho potato king, who sold millions of dollars of Maine potato futures and, at expiration, could not deliver the requisite 49,850,000 pounds. This “great potato panic” resulted in the CFTC’s banning the trading of potato futures indefinitely, “effectively wiping out NYMEX’s most prosperous business.” (p. 134)

And then there was the onion scandal. In the early 1950s “eggs and onions were the [Merc’s] primary markets.” But not for long. A spectacular market-fixing incident engineered by a Chicago trader and a New York trader managed to push down “the price of a 50-pound bag of onions from $2.55 to 10 cents between August 1955 and March 1956.” In the process the two traders double-crossed some major onion growers in Michigan, who turned to Congress for regulatory action. “Despite a strenuous outcry from the Merc and a public relations effort aimed at showcasing the benefits of onion futures, Congress, in 1958, amended the Commodity Exchange Act to abolish the onion market. … [T]rading onion futures became a misdemeanor under federal law.” (pp. 129-132)

Commodity futures, of course, come and go. I, for one, mourned the demise of the pork belly contract in 2011. Whiskey never made it to a formal exchange, even though “on the opening day of the New York’s Produce Exchange [in the mid-nineteenth century], the New York Times published a trade table listing, among other products, 1,010 barrels of whiskey at 19 cents a gallon.” (p. 56) The high-fructose corn syrup market lasted only two years (1987-88). The contract for frozen eggs, introduced in 1949, ceased trading in the 1970s, and egg trading as a whole eventually “sputtered to a full stop.” (p. 74)

Those who are interested in the history of the “food” commodity markets will find many treats in Newman’s book. It is not a definitive history, but it’s worth a read nonetheless.

Monday, November 26, 2012

Maurer, The Spirit of Kaizen

In Japanese “kaizen” means “good change.” Although the word is identified with the dominance of Japanese businesses in the second half of the twentieth century, it had its roots in U.S. government programs instituted during World War II known as Training Within Industry (TWI). TWI stressed that since there was no time for corporations to perform total makeovers to meet wartime needs, they should instead pursue continuous improvement using what they had. As a strategy for change, kaizen “asks for nothing other than small, doable steps toward improvement.”

In The Spirit of Kaizen: Creating Lasting Excellence One Small Step at a Time (McGraw-Hill, 2013) Robert Maurer, a psychologist on the faculty of the UCLA and University of Washington Schools of Medicine, explores the many ways in which kaizen can help organizations make changes with minimal disruption and help people improve both their work and their personal lives.

By instinct most people resist change. The amygdala “smells danger whenever you try to change your routine—because to the amygdala your routine feels secure, good, and safe.” (p. 17) As a result, innovation, by which Maurer means radical change, rarely works. If, however, “the amygdala is like an alarm system, small steps are like cat burglars. Quietly, slowly, and softly, they pad past your fears. Your alarm never goes off.” (p. 18) Rather than looking for the “one big thing” to solve a problem, people should take very, very small steps. In this way they can change habits, even find inspiration, all with minimal stress. (“Inspiration,” Maurer writes, “is much more likely to develop from the habit of consistently paying attention to life’s small moments.” [p. 84])

Maurer demonstrates the value of kaizen in business. Take UPS, for instance, a company “with a kaizenlike attention to detail. (The company saves space at its dispatch centers by mandating that its brown vans park exactly five inches apart, with the rearview mirrors overlapping.) Using kaizen thinking, the UPS engineers recognized that left-hand turns are costly to the company; trucks have to idle longer at intersections, consuming extra fuel and taking up precious time. The engineers edited their GPS software to reduce left-hand turns. UPS has estimated that in one year, this change saved 28.5 million miles off their usual routes and saved 3 million gallons of gas. And within five months of the change, carbon dioxide emissions were reduced by more than a thousand metric tons in New York City alone.” (p. 56)

Lately there’s been a great deal of focus on little things—“little bets” come immediately to mind. I for one am a believer. Making little bets can potentially reap big rewards with minimal risk; taking little steps can bring about significant change with minimal stress.

Let me close with an excerpt from the most recent Yale Alumni Magazine about Richard Levin, the retiring president of Yale, which I believe reinforces this point. “An admirer of Rick Levin’s once told me that she hadn’t started out that way. When he was picked as the 22nd president of Yale, she was unimpressed. He wasn’t charismatic. He lacked the rhetorical flair that had become a hallmark of Yale presidents. ‘But then,’ she said, ‘he went and he fixed this little thing’—circling her hands around a spot on her desk as if it were some roiling problem on campus. ‘And then he fixed that’—and then another problem, and another and another, until she had become an ardent believer.” His presidency was described as “a record of specifics.”

Wednesday, November 21, 2012

Paz, The Forex Trading Manual

Javier H. Paz, the founder of, has written an introduction to the forex market for the retail trader. The Forex Trading Manual: The Rules-Based Approach to Making Money Trading Currencies (McGraw-Hill, 2013) takes the reader from the most rudimentary forex concepts to basic risk management principles, from technical and fundamental analysis to mental conditioning, from a trading strategy to a trading plan. In brief, it is a comprehensive primer.

Is it a good primer? On balance, yes, although it paints too rosy a picture of the predictability of trading revenues. Trading simply doesn’t give you the same size paycheck week in and week out. Telling a novice that he can become quite wealthy by simply averaging 20 pips a day, showing a table where averaging only 50 pips a week with a 1% account risk returns 22% in twelve weeks and a table with the same weekly average with a 2% account risk that turns $5,000 into $132,744 in two years sets him up for unrealistic expectations.

Paz introduces the reader to a trading strategy that he created out of some very familiar parts, the VT (for VaraTrade) Pivot Roadmap. He uses floor pivot support lines (S1, S2, S3), pivot resistance lines (R1, R2, R3) and six pivot midpoint lines. He then overlays his charts with volatility bands showing how high and how low the currency pair (in his sample case, EURUSD) could go at a specific time of day and white space in between for normal volatility. (This indicator is available for a six-month free trial to those who buy the book.) Armed with these charts, the reader is then given some basic rules for trading the strategy successfully.

This strategy, by the way, is based on the start of the trading day at GMT 00:00 and, according to the author, works well in the normally low volatility Asian session.

Paz looked at seven years’ worth of daily prices (2003-2010) and found, among other things, that EURUSD will cross the pivot line 80% of the time and that price will stay below the pivot point 10% of the time and above it 10% of the time. And, driving his 20 pips a day goal, the average pip distance between the price at the start of trading and the new pivot line is 21 pips.

The Forex Trading Manual offers the beginning trader a lot of useful information as well as a reasonable plan of action for trading in a paper account. The novice can’t ask for much more.

Monday, November 19, 2012

Eisen, Currencies after the Crash

Will the U.S. dollar maintain its status as the world’s reserve currency? Will the euro or the IMF’s SDR become viable alternatives? How will China’s policies affect global currency balances? Will gold continue to reassert itself as more of a currency than a commodity?

The nine authors whose original essays are collected in Currencies after the Crash: The Uncertain Future of the Global Paper-Based Currency System, edited with commentary by Sara Eisen of Bloomberg TV (McGraw-Hill, 2013), tackle these and many other topics that every investor should understand. Not only is forex the largest exchange market, with an average daily trading volume of $3.98 trillion in 2010, but currencies are a key component of most corporate earnings.

The contributors to this volume—Jörg Asmussen, Peter Boockvar, Megan Greene, Stephen L. Jen, Robert Johnson, Papa N’Diaye, James Rickards, Gary Shilling, Anoop Singh, and John Taylor—do not all belong to the same economic choir and hence do not speak with one voice. What they have in common is clear thinking and a respect for macroeconomic data. Their writing styles range from breezy to scholarly, but never turgid.

In trying to assess whether, to quote Shilling’s title, “the dollar will remain on first,” it is essential to understand the preconditions for reserve currency status. “According to Lim (2006), there are five factors that facilitate international currency status: large economic size, the existence of a well-developed financial system, confidence in the currency’s value, political stability, and network externalities.” (p. 111) Shilling adds, and makes it his most important condition, “rapid growth in the economy and GDP per capita, promoted by robust productivity growth.” (p. 21)

It’s easy to see why the U.S. dollar is the world’s reserve currency and the hurdles that competitors must overcome to challenge the dollar’s supremacy. And yet the dollar is vulnerable in one key area—credibility—since it “has been falling against other major currencies on a trade-weighted basis since 1985.” (p. 63)

Moreover, there seems to be a “powerful and irreversible trend toward general diversification from the dollar.” But this perception is flawed. It focuses on international trade accounts, not international capital flow. International trade is “a mere 2 percent of total currency transactions.” (p. 80)

Times change, of course, and eventually the dollar will be replaced with another currency or quasi-currency such as the IMF’s Special Drawing Right. “The IMF has already announced plans for the emergence of the SDR as the new world reserve currency,” according to which “the SDR would be endowed with all of the elements of a modern liquid bond market.” (p. 197) In fact, James Rickards maintains that “a global struggle between gold and SDRs for supremacy as ‘money’ may be the next great shock added to the long list of historic shocks to the international monetary system.” (p. 199)

In this review I’ve pursued a single theme, though a dominant one. But Currencies after the Crash offers the reader so much more—for example, an explanation of the Triffin dilemma, an analysis of China’s efforts to rebalance growth, speculation about the future of the eurozone (in the words of one author, “an amicable divorce is better than an unhappy marriage”), even a call for Americans to “rediscover their hard Calvinist core.” Lots of fodder here for the investor.

Friday, November 16, 2012

Greene, Mastery

In my post of October 17 on The Logician and the Engineer, in which I described how George Boole and Claude Shannon came to be such remarkable thinkers, I mentioned Robert Greene’s Mastery (Viking, 2012). Even though Mastery won’t officially be published until November 22 (I read pre-publication digital galleys) and I normally wait for a book’s release date before reviewing it, Amazon already has a dozen reader reviews. So I will join them in jumping the gun.

The book mixes mini-biographies of “masters” (a few of whom are not household names) with how-to advice for the not so masterful, which begins with an exhortation to “discover your calling.” It’s impossible to be a master of anything if it doesn’t fit your talents and personality and if you’re not passionately immersed in it.

The first stage, Greene argues, in acquiring mastery is apprenticeship under the tutelage of a mentor where “your goal is always to surpass your mentors in mastery and brilliance.” Social intelligence makes everything go more smoothly, especially as you become more creative-active (the second level). Finally, in mastery, you fuse the intuitive with the rational.

Okay, so you’ve probably read this sort of thing before. If you haven’t, Greene’s book is a great place to start. But even if you have, Greene’s inspirational bios are worth a read, and some of his advice may actually prove useful on the road to mastery.

In this review, rather than blather on about the book as a whole, I’m going to focus on the section entitled “Alter Your Perspective.”

Conventional minds, he writes, rely on mental shorthand; “our thoughts fall into the same narrow grooves and the same categorizing shorthand.” By contrast, “creative people are those who have the capacity to resist this shorthand. They can look at a phenomenon from several different angles, noticing something we miss because we only look straight on. Sometimes, after one of their discoveries or inventions is made public, we are surprised at how obvious it seems and wonder why no one else had thought of it before. This is because creative people are actually looking at what is hidden in plain sight, and not rushing to generalize and label.” (p. 191)

Greene offers four examples of the most common shorthands, with tips on how to subvert them.

First, “looking at the ‘what’ instead of the ‘how’,” or (very roughly) thinking in terms of nouns rather than verbs. Greene argues that we should pay greater attention to the relationships among things, to structure, rather than to things in isolation. He might have added that we should focus more on process than on a time slice.

Second, “rushing to generalities and ignoring details.” Wrong. “Immersing yourself in details will combat the generalizing tendencies of the brain and bring you closer to reality,” as long as you don’t become lost in the details.

Third, “confirming paradigms and ignoring anomalies.” Paradigms are necessary to make sense of the world, but they shouldn’t dominate our way of thinking. “We routinely look for patterns in the world that confirm the paradigms we already believe in. The things that do not fit the paradigm—the anomalies—tend to be ignored or explained away. In truth, anomalies themselves contain the richest information. They often reveal to us the flaws in our paradigms and open up new ways of looking at the world.” (p. 193) Google came to dominate the world of search because Larry Page and Sergey Brin focused on the “seemingly trivial flaws in systems such as AltaVista, the anomalies.”

Finally, “fixating on what is present, ignoring what is absent” (the dog that didn’t bark). We should pay attention to negative cues, “what should have happened but did not.”

Your mission, should you choose to accept it, is to subvert at least one of your less than stellar investing or trading shorthands. I’m sure you’re creative enough to figure out something constructive.

Wednesday, November 14, 2012

Del Vecchio and Jacobs, What’s Behind the Numbers?

I read What’s Behind the Numbers: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio (McGraw-Hill, 2013) by John Del Vecchio and Tom Jacobs on a power-less Thursday and Friday post-Sandy. But I can assure you that, even I had been able to get back to my computer and had worked assiduously all weekend, I still wouldn’t have been able, as the authors suggest, to use their book (profitably) on Monday morning. Their long-short portfolio is tough to construct. It’s not for the instant gratification crowd.

About two-thirds of the book is directed at investors who would like to improve their portfolio’s performance by unearthing accounting tricks that make corporate earnings look better than they are and—even more important—better than they are going to be. Or, put differently, it is for those who are willing to analyze earnings quality so as either to short stocks with a margin of safety or to avoid ones likely to implode. It “does not advocate … shorting or selling based on overvaluation, fads, frauds, or poor business models, even though these make up the overwhelming majority of stocks sold short. Surprisingly, very bright fundamental investors—those who do bottom-up research on companies and their industries—will only short on these bases, even though they are willing to go long on stock with specific catalysts. It’s as if investors with enormous skill at ferreting out value where no one else can find it suddenly have memory loss on the short side.” (p. 19)

In analyzing earnings quality the investor should be on the lookout for aggressive revenue recognition, aggressive inventory management, assorted unsustainable boosts to earnings, and cash flow warnings. Each of these red flags gets its own chapter, with telling examples.

Let’s say you have done a lot of careful research and have built up your short portfolio. The next challenge is to find a long strategy to complement it. The book’s recommendation is to seek out sound small cap value stocks.

The authors’ actual portfolio results are impressive, at least for the years 2007-2009. Whereas the S&P 500 lost 17.6% over that time (including dividends), a 100% long/30% short portfolio would have returned 6.4%, a 120% long/80% short portfolio would have done the best at 65.9%, and a 50% long/50% short portfolio would have gained 43.7%.

The authors also address the controversial topic of market timing and add a dash of technical analysis to their fundamental mix.

The Stock Trader’s Almanac named What’s Behind the Numbers? the best investment book of the year (although claiming that it’s the best investment book of 2013 is a tad premature). The book is very good indeed. It steers the investor in the right direction by emphasizing risk management, and it introduces him to a basic hedge fund strategy with a twist. The writing style is sometimes a little too cute for my taste, but admittedly I can be schoolmarmish; I assume most readers will enjoy its lightheartedness.

Monday, November 12, 2012

Schwager, Market Sense and Nonsense

Jack D. Schwager, author of the Market Wizards series, has done the investor an invaluable service by writing Market Sense and Nonsense: How the Markets Really Work (and How They Don’t) (Wiley, 2013). Everybody, and I mean everybody, who has an investment portfolio will profit from reading this book.

Never again, for instance, will the investor conflate risk with volatility. Never again will she assume that leverage always increases risk. Never again will she chase high-performing funds. Never again will she disregard the benefits of rebalancing. And she might even consider alternative investments, described in the second part of the book: hedge funds and managed accounts.

Schwager’s first target (well, actually, the second—after pointing out the pitfalls of listening to the recommendations of so-called experts) is the “deficient” market hypothesis. Schwager levels argument upon argument to explain “why the efficient market hypothesis is destined for the dustbin of economic theory.” Here he follows Warren Buffett, who once described the efficient market cabal as the equivalent of the “Flat Earth Society” (see Del Vecchio and Jacobs, p. 176). As a corollary to his argument, and one that I bring up in connection with my recent review of Michael Mauboussin’s The Success Equation, Schwager contends that “markets are difficult, but not impossible to beat—a critical distinction that implies that some winners are winners because they are skilled, not because they are lucky (although some winners will merely be lucky).” (p. 52)

Schwager shines brightest, in my opinion, when he parses the distinctions between risk and volatility—and as sub-themes discusses such concepts as VaR and the Sharpe ratio. He dispels two investment misconceptions right out of the gate: that high volatility implies high risk and low volatility implies low risk. “Although it is usually true that high volatility will imply high risk, this assumption will be false for strategies where downside risk is contained and high volatility is due to sporadic large gains.” Think, for instance, of a strategy that buys out-of-the-money options. And “low volatility implies low risk only if the past can be assumed to be a reasonable approximation of the future—an assumption that is frequently unwarranted.” (p. 108) A fund that sells out-of-the-money calls and puts might have experienced very low volatility in a calm market only to be battered if the market moves sharply in either direction.

Correlation, and its mathematical cousin beta, is another concept that is often misunderstood. It is not true, for example, that “investments that are more highly correlated to the market are more likely to decline in bear market months.” (p. 181) Nor is it true that “the higher the correlation between an investment and a market, the more it will be impacted by moves in the market.” (p. 182)

If these claims are not intuitively obvious to you, you owe it to yourself to read Market Sense and Nonsense. The book is written in clear prose with abundant examples so that even a reader with absolutely no statistical background will understand Schwager’s points. And my hunch is that it will shake up a lot of beliefs that even the sophisticated investor and fund manager mistakenly hold. All in all, kudos to the author for offering the investing world an uncommonly worthwhile book.

Friday, November 9, 2012

Mauboussin, The Success Equation

Michael J. Mauboussin is always worth reading. Those who are unfamiliar with his pieces for Legg Mason may remember him for his highly acclaimed book More Than You Know: Finding Financial Wisdom in Unconventional Places. He’s back with his third book, which has its roots in a 42-page essay from 2010. The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (Harvard Business Review Press) is yet another good read.

The premise is straightforward: if we are to make sound decisions, we have to understand the relative roles that skill and luck play. Sometimes these roles are obvious. If I buy a lottery ticket, anything that comes my way is the result of pure luck. If I take on Tom Brady in a football passing contest, I am guaranteed to lose in a most humiliating way because of the gargantuan gap in skill. But most of the time both skill and luck contribute to a given outcome. If we don’t recognize this, and if we don’t understand the properties of skill and luck, we can fall for outsized claims (“the best trading system ever, 200 wins in a row”) or delude ourselves into thinking that simply by practicing more deliberately we can join the pantheon of legendary traders and fund managers.

It’s bad enough that, given the complex nature of markets, trying to succeed in trading or investing requires more than a modicum of luck. Another problem is what Mauboussin calls the paradox of skill: “As skill improves, performance becomes more consistent, and therefore luck becomes more important.” (p. 53) In investing the paradox manifests itself in the following way: As the population of skilled investors increases, with individual retail investors retreating to the sidelines, the variation in skill narrows, and luck becomes more important. (p. 89)

What’s a poor bloke to do? Mauboussin maintains that “in activities where luck plays a strong role, the focus must be on process. Where skill dominates, performance is a dependable barometer of progress. But where luck is a stronger force, the link between process and outcome is broken. A good process can lead to a bad outcome some percentage of the time, and a bad process can lead to a good outcome. Since a good process offers the highest probability of a good outcome over time, the emphasis has to be on process.” (p. 222)

Mauboussin covers a lot of ground in The Success Equation. For instance, he explains what reversion to the mean is and isn’t (it does not imply that results will cluster closer to the average). And he writes about the arc of skill, obvious in aging athletes but also a problem for the aging investor; the peak age for investing skill is 42.

I’m sure that almost everyone will find something in this book that either he hadn’t thought about before, or that he thought about incorrectly.

Wednesday, November 7, 2012

Smith, Why I Left Goldman Sachs

By now you’ve undoubtedly heard that Greg Smith’s Why I Left Goldman Sachs: A Wall Street Story (Grand Central Publishing, 2012) has little to add to, or even to support, the charges he leveled against the firm in his New York Times op-ed piece. Those looking for evidence that Goldman really is, in Matt Taibbi’s phrase, a great vampire squid, will have to turn elsewhere.

It’s hard to fathom how the author levered his op-ed into an alleged $1.5 million advance except perhaps to suggest that he really did learn how to rip people off at Goldman. As long as I’m being snarky, I might as well point out Smith’s fixation with status and salary. He regularly compares himself to others who advanced through the ranks more quickly than he did. And, although he was initially euphoric over his salary, he begins to feel shortchanged. In the London office, making less than $500,000, he was miffed; he asked for (and not surprisingly did not get) a $1 million bonus.

Smith, who was an intern in the summer of 2000 and became a full-time employee in 2001, essentially divides Goldman into the pre- and post-financial crisis eras. Pre-financial crisis the firm had the highest ethical standards; the client always came first. Post-financial crisis, with former trader Lloyd Blankfein at the helm, the firm lost its moral compass in the search for profits. Such a stark contrast is undoubtedly unwarranted. We mustn’t forget that Smith himself was transitioning from a wide-eyed newbie to a somewhat jaded employee who was not convinced the firm appreciated him sufficiently.

When Smith isn’t being polemical or self-serving, however, he tells a compelling coming-of-age-on-Wall-Street story. He learned what to wear on the trading floor (Brooks Brothers khaki dress pants and dress shirts in different shades of blue) and to how to hang onto clients, even if it meant intentionally losing at ping pong. It was pounded into him that he had to admit and rectify any trading mistake quickly (as he proudly announces, he made only one, which cost Goldman all of $80), and I guess it was a matter of personal judgment just how smashed he could get with clients.

The eager-to-please junior trader is a much more sympathetic character than the vice president who balked when offered the London job. He? London? I don’t know what he expected. Getting sent abroad is often part and parcel of moving up at Goldman. I used to socialize on weekends with a Goldman partner who had earlier logged several years in Hong Kong and London. It was part of the drill.

I’m glad I read this book—if for nothing else than the descriptions of trading floor action. But Goldman lawyers won’t have to stay up late worrying about the potential fallout from Why I Left Goldman Sachs. And I suspect that much more public relations damage was done with the op-ed piece than will be done with this book.

Monday, November 5, 2012

Baker and Nofsinger, Socially Responsible Finance and Investing

The most recent addition to the Robert W. Kolb Series in Finance—Socially Responsible Finance and Investing: Financial Institutions, Corporations, Investors, and Activists, edited by H. Kent Baker and John R. Nofsinger (Wiley, 2012)—follows the series’ familiar format, drawing on the expertise of academics and practitioners from around the world to survey and synthesize vast quantities of research. Its twenty-four chapters, spanning about 500 pages, cover such general topics as finance and society, corporate engagement, and socially responsible investing.

Let’s start with the least socially responsible question: how do socially responsible investing mutual funds stack up against conventional mutual funds? Well, what answer would you like to have? “Several studies report little evidence of a difference in risk-adjusted returns between ethical and conventional funds. However, other studies find that SRI funds can be a valuable source of portfolio risk reduction, even for investors who are not driven by social values. On the other hand, some researchers report a statistically significant cost associated with socially responsible mutual fund investing.” (p. 439) Select your methodology and time period and get your favorite answer.

One of the chapters that particularly appealed to me was “International and Cultural Views” by Astrid Juliane Salzmann (RWTH Aachen University). A couple of takeaways from this study. First, she looks at the law and finance theory, which is based on the differences between British common law and French civil law. “The British common law developed to protect owners of private property against the crown, whereas the French civil law evolved to strengthen state power against a corrupt judiciary. The resultant emphasis of private property rights by the common law tradition supports financial development, and countries that have adopted the common law system generally exhibit better developed financial markets than countries with a civil law tradition.” (pp. 89-90) Common law countries also seem to foster developments in socially responsible finance and investing.

The economic consequences of religion are far from settled. Scholars can’t even document a strong link between religiousness and ethical behavior. For instance, according to studies, atheists are the least likely to engage in insider trading, agnostics the most likely (a rather bizarre finding that almost seems as if it came from a sample of nine traders), and religious commitment appears to be negatively associated with environmentalism. Protestant and Buddhist countries report above-average ethical behavior; Hindu, Orthodox, and Muslim countries exhibit less interest in ethical issues.

Socially Responsible Finance and Investing covers a wide range of topics, from (one of my favorite subheads) “A Palsy in the Invisible Hand: Distorted Consumer Finance Markets” and the use and misuse of financial secrecy in global banking to corporate philanthropy and institutional investor activism, from managerial compensation and social entrepreneurship to green real estate and trust issues in business. It’s not one of those books you read curled up in front of the fire, but it’s a very useful resource for anyone interested in the growing field of socially responsible finance and investing.

Friday, November 2, 2012

Schultze, The Art of Vulture Investing

I think there’s a bit of the vulture in most of us—at least in those who want to buy low and sell high rather than buy high and sell higher. But few of us have either the skills or the chops to rummage through failing or bankrupt companies looking for opportunities. George Schultze is a notable exception. In The Art of Vulture Investing: Adventures in Distressed Securities Management (Wiley, 2012) he shares his investing experiences over the past eighteen years. Written with the able assistance of Janet Lewis, this book describes what transpires in an often overlooked but nonetheless critical part of the financial world.

In an early chapter entitled “Learning to Scavenge” Schultze lays out some of skills necessary to becoming a successful vulture. The most important skill is to know how to use leverage, not leverage in the usual financial sense but the leverage of Archimedes: “Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” The vulture investor must learn to target “what we call the fulcrum security of any failing company in which you are considering an investment. Technically, the fulcrum security is the one most likely to receive equity in the reorganized company after it goes through a Chapter 11 bankruptcy or another type of reorganization.” (pp. 17-18) This fulcrum security is normally a company’s senior secured bonds.

Vultures don’t always wait for an animal to die to swoop in; sometimes they kill the wounded or sick. Similarly, vulture investors can also be short sellers of stock or deeply subordinated bonds of companies that are on the skids (preferably not so obviously sick that their condition is common knowledge) but that have not yet filed for bankruptcy.

Vulture investing is naturally a lot more complicated than shorting dying companies on the way down and buying a fulcrum security either roughly at the bottom or on the way up, even though both of these activities are difficult enough in and of themselves. Schultze takes the reader through a series of case studies that graphically illustrate some of the complexities. Navigating the often byzantine capital structures of ailing companies, for instance, can be a challenge. Trying to put a price tag on tort liabilities, especially long-tailed legal liabilities, is always tough. And maintaining an active involvement while a company is being restructured or after it is reorganized requires a lot of time and attention.

By and large, vulture investing is not a DIY project for the retail investor. But that’s no reason for the retail investor not to read this book. It’s a fascinating account—in fact, so intriguing that I decided that in my next incarnation I wouldn’t mind being a vulture (investor, not bird, thank you very much).