Barton Biggs

Barton Biggs passed away on July 14, 2012. He was a hedge fund manager whose attention to emerging markets. Prior to founding Traxis Partners, he was an investment strategist at Morgan Stanley. After his death, a fund under his sole management was liquidated to return funds to investors.

Even though Biggs was a frequent commentator on financial media, his book actually is more interesting. He kept a journal on some of the indignities of being in the hedge fund business as well as its "very brilliant and often eccentric and obsessive people". This results in Hedgehogging, a book on hedge fund world.


Biggs knows how to write. Instead of giving birdview of the enclosed business, he used smaller pieces rich with conversations and figurative expression. With these small pieces, he fills in his investment theories and explains the hedge fund world. I read through his book and found it is very readable, entertained to some extend. In some sense, his books (he authored two books) are more easily to memorize than theories.

I put in part of the first chapter of Hedgehogging to spike some interests.

The members of the Triangle, opinionated veterans of the investment wars, are not shy about expressing their opinions, and we are all have known each other for years. The insults flew like shrapnel on a bad day in Baghdad. It began when someone remarked that there are now 8,000 hedge funds in the United States, and that hedge fund capital has exploded from $36B as recently as 1990 to probably around $1T today. A long-only manager sourly said something along the lines of the following: “the golden age for hedge fund is about over, and it will end with a bang, not a whimper. The larger capital and the bigger talent pool now being deployed by hedge funds mean that the pricing of everything from asset classes to individual securities is under intense scrutiny by manic investors, who stare at screens all day, have massive databases, and swing large amounts of money with lightning speed. This has the effect of bidding up the prices and reducing the returns of all mispriced investments. Obvious anomalies now disappear, almost instantly. In effect, the alpha available for capture by hedge funds has to be spread over more funds with bigger money, resulting in lower returns on invested capital for hedge funds as an asset class. Risks will also rise as hedge funds have to take larger, more concentrated positions. You greedy hogs are in the process of killing your own golden goose. It’s not only endangered, it is about to die”.

“Don’t you wish,” one of the hedge-fund guys replied from the bottom of his brandy glass, “The golden goose was plumper and sturdier than you think.”

“Global macro is headed for a bust,” another guy said, looking at me. “Too much rookie money. You had better make it quick.” I just stared at him.

“It’s a jungle out there in macro now,” he went on. “There are so many macro players and momentum investors, they’re bumping into each other. There must be a couple hundred new macro hedge funds formed in the  last six months by guys are so green, they can confuse you with their stupidity, and they are big and clumsy, so they can hurt you if you bump into them. And then, stumbling around are the proprietary trading desks of all the big investment banks, plus various rogue central banks like Bank Negara and the Nigerians. Last week, I got crunched between an Asian central bank and some rookie hedge fund guy who panicked on his first macro trip. It’s all very disorienting!” The guy, despite his alleged bruises, looked tanned and rested, so I ignored him.

“It’s like the money game; our nice old game is being played at faster and faster speed by bigger and rougher guys, so it’s getting rougher and more dangerous all the time,” another hedge fund guy said glumly. “Everybody is on steriods. The violence level is soaring. It is like the NFL.”

“As more and more funds are unable to earn sufficient excess returns to justify their fees,” another guy said, “the love affair with hedge fund is bound to cool. But not before all that excess capital takes its toll on the performance record and exalted reputations of the big stars. The alpha pool of the whole hedge fund industry is not growing, but the number of guys trying to drink from it is. Ask not for whom the bell tolls; it tolls for thee.”

“I’m not so sure the alpha pool isn’t growing,” I argued, “As all these new, naive, trigger-happy crazies, long on aspiration and short on experience, enter the business, a lot of them will get creamed. Then their losses will expand the alpha pool for the rest of us.” I noticed one of the veterans was looking at me kind of funny, as though he was thinking, “Who are you, punk, to go talking about naive talent?”

“Leverage, leverage, leverage --- that is what is going to wreck you guys eventually,” said the long-only guy. “Actually since LTCM with its huge balance sheet and various forms of tail optionality (whatever that means) blew up, hedge funds have been reducing leverage. Instead of them, it’s their investors, both individuals and the fund of funds, who are putting on the leverage. The clients of the fund of funds are unhappy with the meager returns they are getting, so the fund of funds goes to the bank and borrows. And the banks, particularly the European ones, are falling all over themselves to offer credit to their wealthy individual clients to leverage up their hedge-fund holdings. Theorectically, it makes sense. A basket of diversified hedge funds has lower volatility than one fund, so why not leverage it up to magnify the returns?”

“Yeah,” said somebody else. “It makes sense until a bolt from the blue, a tsunami wave, a two- or even three-standard-deviation event happens, and then the you-know-what hits the fan. The hedge fund basket has a 10% drawdown not in a year but in a month, and a big leverage fund of funds could be down 15% in a flash. What happens to the whole hedge fund universe then? I will tell you what. The frightened fund of funds clients redeem, the fund of funds in return have to redeem from their hedge funds, and the whole asset class does an extreme shrink. Furhtermore, there are no safe heavens. The long-short market neutral funds get killed, too, because when they have forced liquidations, their longs go down and their shorts go up.”

“Meltdown,” said the long-only guy, “not just for you perps but for everyone else and me too.” The evening was over.

Jamie and Sandy

JP Morgan CEO Jamie Dimon recently became the focal point in banking sector. The "London whale" loss brought him into a series congressional hearings that may cause new banking regulations. Right after this bump, JPM's succession plan was reported such that younger executives move up the ladder. Some speculated that Dimon is planning his successor. Maybe simply a coincidence, Jamie's old mentor and boss, Sandy Weills got some face time by commenting big banks should be broken up.

These two figures showed almost at the same time is rare. After Dimon was fired by Weills, there has been no report the two had conversations. Weills once on a New York Times interview expressed that firing Dimon might be a mistake. But that is all. One can hardly understand how close the two was. Here is compiled section from "Last Man Standing" on how they started their long relationship.

Dimon graduated from Harvard Business School in 1982. He got three offers from Goldman, Lehman, and Morgan Stanley. The most obvious pick was Goldman. Dimon wasn't sure and asked advice from Weills. Weills was the chairman of the executive committee of American Express and in charge of all the treasury and financial functions at AE. Weills hadn't been such a large organization and in his learning curve. He floated a fourth option to Dimon. "How would you like to come be my assistant and we can learn this thing together? We can learn a heck of a lot about how corporate America works and how a diversified financial services company works. You probably won't make half of what you'd be making at Goldman, but that's a far more concentrated and high-pressure job, and I don't know what you'd be building." Goldman's investment banking model didn't build anything, indeed, but take commission in trades. Dimon was intrigued by this proposal that he could build something. As Dimon put it, "My goal in life was not to be an investment banker. I loved the concept of helping build a company. And Sandy had done it before with Shearson. I thought I could always change my mind if it didn't work out. It was a little risky, because Sandy was just chairman of the executive committee at American Express --- whatever that meant --- but he was honest with me. He said, "I'm not sure it's going to work out here, but I think you're a smart kid and we'll see how it develops.'"

This was a good fit between them back then: Weills needed a young talented protege and Dimon thought Weills could send him to executive suite quicker. This relationship worked out very well at AE and later at Citi Bank. Regardless what happened later, Dimon was lucky to have Weills' honest advice. He must have had very good connection even in his school days so that he could dial Weills' number and had an open talk. This story is more intriguing and worth exploring more but largely unknown. But we can tell that Dimon indeed is a high power figure before his days came.

At this point, Gerald Loeb, the most quoted Wall Street pro,once said that, "one's greatest assets are his mental competence to do something useful and his connections. Therefore, establish some emergency connections away from home." Loeb stressed away from was to hedge risks from home turf. But the point is clear enough.

One profitable gas station business

Everyone of us has been into a gas station knows that gas stations make money by selling gas and diesel. That is their main business that requires large investment. However, something else can be more profitable than this. Rarely people would be aware of this until Bank of America announced the latest cost cutting plan.

BofA plans to discontinue lease contracts with about 1,600 gas stations and malls for their ATM machines in these stations. To install an ATM in a gas station, the bank needs to rent the space and communication lines. How much the cost of installing an ATM? It is surprisingly costly: $1,700 per month. It is hard to image an ATM would cost much more than a one-bedroom apartment. That is totalled $32 million for 1,600 ATMs. Also consider how much business would be brought to BAC by these machines, it is definitely necessary to shut them down.

BofA has the second largest number of ATMs in major banks with about 16,000 ATMs. JP Morgan has about 18,000 ATM national wide. Wells Fargo has about 12,000 and Citi Bank has 10,000. ATM in branch would cost 40% less compared to the ones installed in other properties.

This new round of cost cutting at BofA aims to make the bank more profitable. It has achieved some success by selling properties such that their Q2's numbers aren't that bad. With relentless cost cutting efforts, BofA will become leaner, hopefully more focus on retail banking. Buffet said he hoped Wells could have 40% of mortgage market. The dominance is built on long term business built up. Same should be done at BofA's retail banking business. It seems BofA has realized this and moved on this track.

Buy houses at bottom?

The most heated debate now is whether the housing market has bottomed out. Media has propagated that housing indexes and prices have stabilized in the first half of 2012. That is Indicator #1 that the housing market is bottom. In addition to price, record low mortgage rate fuels appetite to catch the incentive before it is gone. This is Indicator #2 that the housing market would be heading up. Both of these are buy signals.

However, people aren't easily be fooled by media and banks after the subprime case. Here is a list of factors that may affect purchasing decisions:

• National wide, the housing market is still a buyer's market with a few exceptions that prices have appreciated such as the Bay Area, New York City, and AZ. So there are signs of life of recovery. But house prices aren't as volatile as stock market. It will move slowly with clear trend. The trend now is indeed at the bottom.
• The driving force pulling up house prices is the lowest mortgage rate. It is true that in many regions baby boomers need to use their house to finance retirements. It is also true that in other regions baby boomers are cash fluent to buy investment housing for next generations. Either way, baby boomers are a strong factor to prevent prices falling further. 
• Rental market has gone up to a high level because of foreclosures. Shrewd investors have noticed that banks are manipulating their foreclosure and short sell properties to wait for a higher price. A simple delaying tactic. The inventory may still take a while to melt. So banks don't want to see prices drops further. With strong revenue in the reports, banks seem have time on their side for this tactic.
• Given the historic low mortgage rate, if Fed increases rates back to 3% in 2014 gradually, house prices will come down again. It is impossible to keep printing money for free forever. That translates to a 2-year honeymoon period if purchasing a house now. After that, buyers would need to wait for the next housing bubble or inflation. This is a long time.
• Real estate tax is another important factor. About 40 to 60% real estate tax goes into public education. So if there is a budget deficit in where you are considering buying, think about the worst case what would happen to your RE taxes. When your house suddenly has a high appraisal, you would pay more taxes. 
• In some locations, rentals are hot and valuations are more resilient than others. These are good signs that even when interest rates go up, prices won't drop too significant or not dropping at all. Of course, houses are hard to find too. But it is not impossible.
• Banks are cautious on lending. They don't want to see regional house prices more than 3-3.5 to household income, in general. Therefore, from regional median housing prices, you can actually calculate household income in that area. Then you can use the unemployment rate in the area to forecast (with safety buffers) how the housing price would fluctuate.

So in the coming 2-year, housing is at a bottom. For buying, it needs great due diligence. There are opportunities. 

A star hedge fund manager's run on its doom investment, repeatedly

The once christened "the next Warren Buffet" on the now-embarrassing Business Week cover story, Edward Lampert, always attracts media coverage since he restructured Kmart and Sears to become now Sears Holdings. Mr. Lampert's ESL Investment's RBS Partners controls about 64% of Sears Holdings. The reason behind Business Week's story was the hope Mr. Lampert could repeat Buffet's deem on Berkshire, which originally was a textile company and turned into a conglomerate by Buffet. But it is proven that they have different path.

The theme repeats in this way: Sears has consistently declining revenue, cash flow, uncompetitive price, enlarging number of unhappy customers, and dwindling customer base. Solutions have been closing stores, selling assets, reducing cost. All analysts claimed Sears' death and calculated how much it'd value. But its stock price enjoyed wild ride on every negative news. The logic behind the rise was the stock rise was that Mr. Lampert always bought more when price dropped and speculation that he would privatize the company came next. This repeatedly sent stock upward wildly. Why did he buy such a sinking ship?

Lampert's ESL is a $12 billion fund that focuses on a few investments such as Sears and AutoZone. The fund's performance is hard to come by to public. Lampert had his partners sign stringent confidentiality agreement. He was able to snuff a rebellion in 2008 when his fund dropped 25%, according to report. What this means was that once investors gave money to ESL, they can't withdraw for a few years and they can't reveal how the fund does. There was an attempt to vote on a provision to alter the partnership agreement in 2007. In the vote, original investors used their comparatively larger interest to veto the change.

For many investors, Sears has value that only can be realized when it is liquidated. Its hidden value is its brand names and real estates. Sears value ranges from $30 to $300. So no one really knows how much it is worth. As Lampert closed more and more stores, the median number has been down. But a consensus is that it is about time Sears gets liquidated after years of loss.

As no ones how much it is worth, the best way to Sears is buy at its low and sell its high. It still has a long way to go before its death. This also means capital will be locked for a long time for those "long-time" Sears investors.