Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Investing, Philadelphia Style
Land ownership once was the only practical form of savings, until banking matured in the mid-19th century. Philadelphia took an early lead in what is now called investment and still defines a certain style of it.

Personal Finance
The rules of financial health are simple, but remarkably hard to follow. Be frugal in order to save, use your savings to buy the whole market not parts of it, if this system ain't broke, don't fix it. And don't underestimate your longevity.

Dislocations: Financial and Fundamental
The crash of 2007 was more than a bank panic. Thirty years of excessive borrowing had reached a point where something was certain to topple it. Alan Greenspan deplored "irrational exuberance" in 1996, but only in 2007 did everybody try to get out the door at the same time. The crash announced the switch to deleveraging, it did not cause it.

Financial Planning for a Long Retirement

How should an individual investor ensure they have enough money for retirement?

Such a person is often a professional or entrepreneur who has worked to accumulate wealth. Legions of "advisors" are lined up to take this money and manage it or else to sell "products" that promise to solve some problem or other.

A person who has created their career and their wealth from scratch by intelligence and hard work can also manage their investments themselves, or at least supervise the process from a position of strength created by knowing what needs to be done.

This collection of articles explains to the individual investor how to take control of their wealth. They may eventually decide to look for help from an advisor but they will retain control of their assets and they will know what to do.

Financial Planning videos on YouTube

Right Angle Club 2010
2010 is coming to a close, a lame-duck session is upon us, and probably after that will come two years of gridlock. But the Philadelphia Men's Club called the Right Angle, keeps right on talking about the current scene. A few of these current contents relate to speeches given

Disappearing Stock Power

The Right Angle Club of Philadelphia recently heard two presentations on newer investment strategies, one by our member on hedge funds and private equity, and a week later by his guest from Black Rock, on ETF funds. For the purpose of this review, both presentations ultimately got around to the same issue.

In the case of private equity, the investor purchases a share of aggregated profits from a company in the business of buying substantial or controllling interest in corporations, usually underpriced or underperforming ones. And then, the private equity fund attempts either to fix up the company and sell it, or fix it up and hold it indefinitely. Whether or not he achieves a profit, the individual investor in the fund loses the opportunity to vote the shares, or has it offered in such an awkward way the opportunity is meaningless.

Hedge Fund

A hedge fund similarly buys and sells stock on its own account, employing the money of investors, and generally adding huge amounts of borrowed debt. In this case, the stock is often held for such short times that voting rights are lost in the registration requirements. Taken as a whole, however, the issue is substantial, since it is reported that 70% of recent transactions have been conducted by unattended computers operating by pre-arranged contingency instructions, often responding in fractions of a second. While the resulting immobilization of voting rights is substantial, the main problem with hedge funds has been the way very small profits have been magnified by staggering amounts of borrowing, potentially causing very large losses if the transaction system is slowed for whatever reason. While hedge funds did perform well during the 2007-2009 crash, it will be 2012 before the incredible volume of transactions can be analyzed to see how close we were to disaster. There is definitely a risk in doing nothing, but probably less than the risk of ill-informed legislation making matters worse in some way.

In the case of ETF, the operator or "manufacturer" of the fund attempts to buy blocks of stock in all or representative samples of the companies listed on some index, weighted in proportion to their weight in the index. The intent is never to sell that stock, merely evaluating the fund price and its dividends as a mathematical exercise, and repurchasing or reselling the calculated bundle to other investors, but never disturbing the contents of the bundle unless the index changes its composition.

In all third-party investing cases except hedge funds, the advantage is that reduced tax and transaction activity saves costs, and avoiding internal selling of stock means essentially no taxes are payable until the investor ultimately sells the fund. The managers of funds maintain that these tax and overhead savings completely compensate for losing whatever opportunities for profit would come along and be exploited by expensive "active" managing of the funds. (Some investment funds employ more PhD's than any American University does.) Even if the performance turns out to be somewhat lower, there is a safety factor of exactly matching the averages, and thus agreeing to surrender the opportunity to join half of the universe of investors in beating the average, in order to avoid joining the other half of investors in doing worse. Furthermore, distributing the investment over a large group of corporations confers diversification, and thus surrendering the chance of a windfall profit in return for avoiding the occasional disastrous loss. In a sense, the fund investor no longer hopes for a company to do well, he hopes for the whole nation to do well. Summarizing the details, these funds provide safety of diversification and reduction of turnover costs, in return for assured but marginal above-average performance. Since this outcome is so greatly superior to the actual experience of non-professional investors overall, it is highly attractive to many investors, and should be attractive to more of them.

In addition to these common features, the hedge funds and private equity expose the investor to the risks and rewards of choosing a skillful manager, who may or may not choose the portfolio wisely, and who may or may not use leverage wisely. The choice of portfolio companies, on average, justify a greater degree of borrowing as their quality improves, and all investment borrowing involves a risk that interest rates may go up for reasons unrelated to the investment. In the recent debacle, hedge funds did comparatively well, but nevertheless there are times when it is unwise to borrow against even the safest securities. And finally, because of the risk of stock market raids by outsiders, hedge funds are quite secretive about their portfolio contents, and force the investor to "lock in" his illiquid investment for several years at a time.

There remains one characteristic of both funds, and for that matter mutual funds, annuities, life insurance and all other forms of aggregated investing through a third party. The third party retains the right to vote the shares, admittedly with some little-used and generally unworkable opportunities for investors to request their own proxies. Such third parties almost always vote the shares in their custody in favor of management. There are occasional exceptions, as when union-managed funds will vote their shares in a political manner, or as when some mutual funds attempt to obtain pension fund business in return for cooperation on selected proxies, or in one legendary story the custodian was instructed "Always vote AGAINST any management proposal." But these are presently exceptional situations. In the vast majority of cases, the proxy votes effectively disappear, and control of the companies in the portfolio gradually gravitates into the hands of those few stockholders who retain direct ownership, and take the trouble to vote it. In fact, it is increasingly the case that the most effective way to frustrate a management proposal is not to vote against it, but to abstain entirely, in the hope that a quorum cannot be assembled.

Another popular movement augments this unfortunate situation. Increasingly, it is urged that top management be paid substantial parts of its reimbursement by stock in the company or options on it. The argument is that it is important to align the motives of top management with the rest of the stock holders. Reflecting concern about some recent events, such stock is or should be forced to bear the covenant that it may not be voted in a stock take-over by an outside raider, to frustrate the commonly used inducement to the manager to sell out his stockholders in a merger. Even when this particular contingency has been foreseen and prevented, the effect of increasing the shares in the hand of management and decreasing the voting shares in the hand of the outside public by freezing them in third-party funds -- soon puts the idea in the heads of managers that they own the company. The recent public indignation about inordinately high salaries for top management, can in large part be traced to the plain fact that voting control of the companies is visibly shifting into the hands of the people who receive those salaries.


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