What are fund managers talking about?

Hedge fund industry is having their meeting to discuss recovery road map. Besides fanfare meeting venue and spotlight news, what are they talking about?

Being hedge fund managers and their families can be very embarrassing. One story is a daughter of a manager, who often travel on their own jet, asked her dad to let her try one time in commercial flight on her birthday. She felt very lost as everyone in her class had been to an airport and stand in the security checkpoint. But she didn't have that experience at all.

Conversations between managers may be tricky too. Managers are supposed to share favorite stock or concepts and reasons. These group meetings have lots of kibitzing because of ego. Managers may or may not get ideas. Longs and shorts are indicators on market sentiments.

If a manager is really recommending a position he has been in, it may be exaggerated. That is normal. No one wants to hear that his kid is not a beauty. However, if a foul will be called when one lies to others and profit from the lie. He may be kicked out of the community forever. It is dishonest and cheating.

More transparent pensions

John has a pension plan. He once called the managing company about the plan. What they told him is that he can start planning his pension before his retirement age 65 or wait until then. John wasn't sure how the 65 retirement amount is calculated. The company rep simply told him that his employer put money in some "secured" investment so that the future value can grow at about 5% to the time his retirement. Surprised, John asked, "how do they guarantee that?". Surprised by the answer from the rep again, "we don't know, but there is a federal fund can guarantee some, probably all of your pension." That made John think immediate withdraw may be a better way. This is a true case.

Now the situations start to change.

Many pension plans invest in municipal bonds, which can be minefields. It is very difficult to spot camouflaged explosives. It is true that pensions are federal protected but since the government doesn't visibility on pensions, it is hard to predict disasters if there is any coming. Now the Governmental Accounting Standards Board (GASB) is determined to improve pension's disclosures. They proposed the disclosures of pension liabilities on the face of the entity's financial statements. In some cases, the government also calculates the present value of pension liabilities more conservatively, based on high-quality municipal bonds, rather than a plan's own expected return. Quite often, a plan is overly optimistic about their returns. Pension is also directly related to employee's employment duration so that they get paid based on the duration. But on the pension plan management side, they don't use the actual duration to calculate pension costs. What is used is 30-year duration. This ought to be changed to base on employee's duration.

It provides more visibility to government and consequently, employees. But pension liabilities will be up. A higher levy on liability is better than illuminated return. Safe better than sorry.

Yale Endowment

Lately there are many universities ask supports from their students, student families to more funding so that tuitions can be tamed. Under the gun of legislation, such pursuit may not always work. Let's see how Yale, a private ivory university, as a case study.

The performance of university endowments is vital to the survival of a university. It is very difficult for universities to finance itself on tuition alone, and alumni contributions to meet the shortfall (how much is the return rate for those contribution appeal letters from university fellows?). During a time that many public and private universities are screaming for funding, it is a good case study on Yale Endowment performance.

Yale was founded in 1701, but the endowment was created in early 1800s to seek the independence of the college. Alumni contributed gifts. The treasurer and two trustees were responsible for the endowment. However, the first generation trustees almost sank the whole endowment because they put money solely in a bank they founded it.

Yale survived the trustee's bungling. By 1900 the endowment was $5M and still supervised informally and casually by the treasurer and the trustees. A board of trustees meets on the affairs of the university. In the Great Recession, Yale was 42% in equity so it was hit hard. After that, Yale mostly put their endowment in fixed income, which underperformed significantly during the 60s-80s bull market.

Changes came in 70s when Yale started to own partially a company called Endowment Management &Research (EMR). EMR invested most of the endowment in high growth stocks which started to peak in late 70s. EMR was terminated by Yale.

In 1985, David Swensen was recruited by Yale. That is the real turning point for the endowment. In the coming 20 years, the endowment grew at 21.1% with $22.6B asset. Very little invested in domestic and a lot in real estate, foreign equities, income strategies, and timber. The investing principles are 1) be owner of equities 2) diversified portfolio 3) select great investment managers 4) use outside managers 5) reward outside managers accordingly.
What are outside managers? They are hedge fund managers. Since these outside managers had added one more layer in endowment management and they are eager to demonstrate their performance, performance is the best in all universities while Swensen was in charge. According to Charlie Munger, Warren Buffet's partner, if one layer of fund management works, one more must be better.

In this case, fund management plays a critical role in Yale's success. It is always not late to learn.

Investor grades

Investors, of all classes, can be graded into superstar, good, and journeyman. Superstars consistently, in terms of decades, put up big numbers so that they can afford running their own money. That means less pressure and more controllability. Good ones outperform and have long-term records of above the par by a few points. Journeymen had occasional luck to beat the index. The rests are bums.

Good investors and journeymen are good people. They put in long hours. They are smart, articulating, hard working, and have their own pattern. More important, they are highly paid, thanks to their clients. This anomaly is because investment business is a growth business, which means the a few points performance is after their fees deduction. That makes differences to the firms.

Superstars are quite different as they don't have firms or shells to dwell. They are managing their own fate. It is always a puzzle what makes similar education, similar work habit, similar background people to become superstar or something else. Luck is the most resounding and easiest reason. But how can luck siding superstars by decade counts?

The more likely thesis is the instinct, a magic market instinct, and focus, that give edges over others. To understand this, that means superstars have good learning ability at all times so that their instinct can be honed consistently. Remember this is a life time game and you have to love it, otherwise it is a boring one. Keynes loved this game because it was strictly out of the intelligent challenge.

Instinct and focus imply a lot: discipline, self-control, stay calm, learning ability, so on and so forth.

AT&T's new networking plan

AT&T terminated its $30/mo unlimited networking plan last week. Verizon unveiled its iPhone supply, also in last week. Although rumors about Verizon's iPhone is inferior to AT&T's version, it makes sense given the good relationship so that AT&T still has an edge in terms of devices. However, the termination of unlimited networking plan seems de-leverage the advantage.

Burden on AT&T's network is the main cause of the move. It is unclear others would follow. In fact, if no one follows the move, that would make AT&T's plan less marketable. Therefore, it is a good time for others, including Verizon to further gain market share (Verizon is the number one in number of users. Of course, technical obstacles are the same or similar among all carriers. . But at least the others know the aftermath of such plans so that they are more prepared. Ways like pricing and account level but still unlimited networking plan are more marketable.

In short, AT&T made a bad move but it might be inevitable for them.

Psychological important of an income portfolio

Ninety nine percent working class prefer to having stable income, the paychecks release bi-weekly, or monthly. Here is an interesting experiment: let a group of people to decide how they would choose to obtain $3000 in a month: daily, weekly, bi-weekly, and monthly. The group of people is selected such that they could have similar financial conditions or varied financial conditions. The results would have more weekly and bi-weekly requests than the other two. If further the length to a year of $36000, the percentage of preferring to one-time annual payout of $36000 drops to 1%.

This is an important psychological observation: we, human being, mostly prefer stabilizability over instant changes. It is just the way we operate so that we feel we are insured by the income flow. For the 1% who prefer volatility, they should be more accurately called entrepreneurs. To be financial sound entrepreneur, be prepared such challenges in addition to business factors.

So don't undervalue the need of having an income portfolio. Here are something need to consider while doing so:

Select companies with capital appreciation that choose to increase dividends over time. That is translated to good cash flows, net income and asset values. Then move on to yields. If companies maintain payout ratio --- dividend as a percentage of net income --- above 30% to 60%, that is good. Finally, look at the potential of having dividends boosted in the future.