Friday, January 30, 2009

Barron's Best Online Brokers

Just was reading over Barron's annual 'Best Online Brokers' piece for 2008. As we await their list for 2009, I wanted to check out how the brokers stacked up against each other last time around. In it, they detail the pros and cons of all the retail brokerages, ranking them by various investing styles and then overall. Tradestation was the winner, with thinkorswim and Interactive Brokers close behind. Those are definitely some great names up at the top. But, I also noticed that yet again, TradeKing has made it in the top echelon of brokers (head to the bottom of the page for a $150 transfer discount). A year or two ago, I'd never heard of them, but their consistent top performance has me intrigued. Here's some interesting facts I noted from the Barron's rankings regarding TradeKing:

  • They finished 6th overall out of 23 different brokerages for 2008.
  • They received their highest scores in the categories of 'Research Amenities' and 'Portfolio Analysis & Reports.' (You'd expect that sort of stuff from the higher commission, full-service brokers like Schwab. But, TradeKing received great marks and has low commissions of $4.95 a trade).
  • Ranked 3rd overall in the 'Best for Buy & Hold' category
  • Ranked 6th overall in the 'Best for Options Traders' category

Barron's highlights some of the features such as, "A recent addition is Scivantage's Maxit, an automated cost-basis and portfolio-tax reporting system that not only tracks capital gains, but helps make better tax-related trading decisions."

It looks like they've got a current promotion running as well: Click the picture below to receive $150 for account transfers. It says you just open an account, fill out the ACAT transfer form, and fax your old broker account statement with the transfer charge on it to 561-988-0131.

Open a TradeKing account today

Additionally, they were ranked the #1 discount broker by Smart Money in 2006 & 2007. Cheap commissions, reputation of good customer service, solid features, and a bunch of rewards/recognition for a discount brokerage. Sounds like they're doing things right.

To read more about the various brokers, check out the entire Barron's piece here. And look for their 2009 piece in the coming months.

What We're Reading (1/30/09)

Mark Cuban's advice for investing in start-up companies (All Things Digital)

Steven Cohen's (SAC Capital) shrink is in high demand (Portfolio)

Hedge fund back to basics (Alpha)

Hyperinflation survival guide (Value Plays)

Hedge funds help fund Obama inauguration (FinAlternatives)

Video: Ascent of Money (via Paul Kedrosky)

Jeff Rubin on Reflation/Deflation (.pdf via CIBC)

The life of a daytrader (NY Mag)

Peter Schiff was wrong (Mish) / Peter Schiff responds to critics

Is this the end of Warren Buffett? (Doug Kass,

Bid on a dinner with T. Boone Pickens (DallasMorningNews)

Peter Schiff Talks U.S. Debt

Peter Schiff recently wrote a piece for the Wall Street Journal, entitled, 'The World Won't Buy Unlimited U.S. Debt.' He writes,

"These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people. When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher) and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)

In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver.

As absurd as this may appear on the surface, it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on. Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

But just because the game has lasted thus far does not mean that they will continue playing it indefinitely. Thanks to projected huge deficits, the U.S. government is severely raising the stakes. At the same time, the global economic contraction will make larger Treasury purchases by foreign central banks both economically and politically more difficult."

We've covered Schiff's thoughs on the blog numerous times before. He talked about the treasury bubble here, as well as the current crisis and gold here. Also, interestingly enough, we've noted that there seems to be a grassroots campaign to try and convince Schiff to run for U.S. Senator (CT) in 2010:

You can read his WSJ piece in its entirety here.

Thursday, January 29, 2009

Hedge Fund D.E. Shaw & Co Files Amended 13D on Orient-Express Hotels (OEH)

The $33 billion hedge fund D.E. Shaw & Co has filed an amended 13D with the SEC disclosing a 6.3% ownership stake in Orient-Express Hotels (OEH). Keep in mind this is an ongoing situation and is not a new filing, but merely an amended one. Their aggregate amount beneficially owned is 3,218,678 common shares. You can view the rest of their portfolio holdings here. The filing was made due to activity on January 12th, 2009. On that date as per the filing, D.E. Shaw,

"... filed a petition in the Supreme Court of Bermuda (the “Petition”) against the Issuer, the Issuer’s subsidiary Orient-Express Holdings 1 Ltd. (“OEH 1”) and the members of the Board alleging, among other things, that the Issuer’s current ownership and voting structure is unlawful under Bermuda law, and that the Board exercised its fiduciary powers for an improper purpose in causing or procuring OEH 1 to acquire, hold, and/or vote Class B Shares of the Issuer (the “Class B Shares”). The Petition requested, among other things, that the court issue orders (i) providing for the classification of the Class B Shares as non-voting treasury shares pursuant to Bermuda law, (ii) providing for the cancellation of the Class B Shares, (iii) restraining OEH 1 from exercising voting rights with respect to the Class B Shares, and/or (iv) providing such other relief as the court may deem proper."

D.E. Shaw was founded in 1988 by David E. Shaw and manages around $33 billion as of December 1st 2008. They focus on intertwining technology and finance and are a hedge fund, private equity firm, and technology development shop all in one. They employ mainly quantitative strategies and do a lot of statistical arbitrage. Shaw oversees strategic maneuvers at the firm, but no longer is active in the day to day operations. He received his Ph.D. from Stanford University. Some notable former employees include Jeff Bezos (before founding and Lawrence Summers, who recently left the firm to serve on President Elect Obama’s economic team. In Alpha's latest hedge fund rankings, D.E. Shaw is ranked 6th in the world.

Taken from Google Finance,

Orient-Express Hotels is "a hotel and leisure group focused on the luxury end of the leisure market. The Company owns and/or invests in 51 properties consisting of 41 individual deluxe hotels, two restaurants, six tourist trains and two river cruise businesses. These are located in 25 countries worldwide."

Public Disclosure of Short Positions is Probably a Bad Idea

A month or so ago, we saw that some of Obama's aides were pushing for a disclosure of hedge funds' short positions, similar to how funds disclose long positions with 13F filings. And, we thought it would be interesting to consider the pros and cons of such a maneuver.

While we would love this because it would give us even more to blog about in our hedge fund portfolio tracking series, we ultimately feel that it would be bad for the markets. Remember that massive drop-off in the markets back in October and November? Yea, part of the reason for the massive selling in certain equities was funds "front running" each other. When you 'front run,' you are basically shorting the long positions of other struggling funds that you figure they will be forced to sell. Initially, funds were forced to sell positions due to the fact that they were struggling due to weak performance and/or redemption requests. This situation was further amplified when the lions started to attack the wounded wildebeest. At the time, many funds were liquidating and/or seeing a large amount of redemptions.

Once other funds got wind of who the weak were, they went to feast. 'Only the strongest will survive.' By merely pulling up a 13F filing with the SEC or doing some poking around, you could get a general idea as to what some of that fund's largest holdings were... holdings that would typically take a few days to sell out of, if forced to liquidate. And, the front-running began.

Now, imagine a similar scenario where other funds 'front-run' weak funds' short positions. But, here's the difference: Those weak funds could only lose a finite amount of money on their longs they were forced to sell. If/when the stock goes to $0, the cycle is done. However, if a fund is short a stock and they get caught in a squeeze, they can lose an exponential amount of money (as there is no ceiling as to how high a stock can go - as recently illustrated in the Volkswagen short squeeze). So, imagine a weak fund that is short a ton of shares of XYZ company, one of their largest short positions. Everyone gets wind that they are weak and starts buying shares, squeezing the weak fund that is short, and forcing them to cover. After all, it doesn't take very long for a stock to skyrocket. The potential fund losses could be exponentially greater and trigger yet another wave of weak funds being forced to liquidate positions. The main point here is that such a disclosure could lead to even more volatility and even more chaos. There is one caveat with this theoretical scenario though: Its not as easy to figure out their short positions as it is their longs. Funds are required to disclose their long holdings to the public, but not their shorts. And, a fund's short book is often one of their closely guarded secrets. So, if you require public disclosure of such shorts, then other funds can quickly prey on the weak yet again.

This is just one tiny theoretical example, but there are many reasons to oppose this proposition. Throwing yet another wrench in the current system would give many funds pause about how they normally go about structuring their portfolios. Funds would undoubtedly try to find new, complex ways to short without having to disclose it. As we just mentioned, their short positions are often their prized secrets. And, shorting is an essential part of not only many hedge fund strategies, but also market liquidity. Remember the shorting ban? Yea, that worked well. /Sarcasm. While disclosing shorts is obviously not as extreme of a move as eliminating shorting altogether, there would definitely be repurcussions. Additionally, we wonder if disclosing the short positions could possibly have the 'Warren Buffett' effect, but in the opposite direction? Many investors piggyback Buffett's plays and when he discloses a position, the stock usually ramps up and gains more following. So, imagine a scenario where a couple of prominent hedge funds are required to disclose they are massively short XYZ company. You can bet that many people will piggyback that trade and possibly send that stock spiraling downwards. And, this is exactly what has happened in the past. For instance, take David Einhorn of Greenlight Capital. He laid out a short thesis for Allied Capital a couple of years ago at a charity investment conference one night. That next day, while other stocks opened for trading, Allied Capital remained closed because there were so many people trying to short it. Einhorn even wrote about this story and his encounter with Allied in his book, Fooling Some of the People All of the Time. The main point here is that such a disclosure proposition could have many unintended consequences and could possibly do more harm than good.

You can bet that nearly all hedge funds will be opposed to this disclosure if it will be available to the public. Most, however, have no problem revealing the positions in private to regulators. If it is revealed to the public though, that's where many hedge funds take issue. And, many prominent hedge fund managers shared this exact stance when they testified before Congress. And, we feel this is the correct move. By disclosing this information privately to regulators, we can (hopefully) have better risk management. That is, assumming, we have faith in regulators to do their job. Exactly how regulators will use this information, we're not entirely sure. But, we do know one thing: Disclosing such information to the public could potentially open a can of worms.

Yale's David Swensen Video Interview

Here's Charlie Rose's interview with David Swensen of Yale.

Wednesday, January 28, 2009

Art Samberg's Pequot Capital Management: Portfolio Update (13G Filings)

Art Samberg's hedge fund, Pequot Capital Management, has filed a few amended 13G's with the SEC, detailing changes to their portfolio made on December 31st, 2008. Firstly, they have disclosed a 0% ownership stake in Healthcare Services Group (HCSG). They have completely sold out of their position, having previously owned 2,500,199 shares. You can view the rest of Pequot's portfolio holdings here.

Secondly, Pequot has also filed an amended 13G and disclosed a 19.4% ownership stake in Akorn (AKRX). They currently own 17,293,857 shares, down from their prior holdings of 22,974,772 shares. So, they sold off a decent amount of their position.

Lastly, they also disclosed a 92.8% ownership stake in (TUYU). This is a new holding for them, as they previously did not show a position in their last 13F filing. This is a slightly complex ownership stake. Taken directly from the 13G filing with the SEC, they hold,

"237,208,429 shares of Common Stock issuable upon exercise of a warrant to purchase 7,161,040 shares (the “Series B Shares”) of Series B Convertible Preferred Stock of the Issuer, par value $0.001 per share (the “Series B Preferred Stock”), which converts into Common Stock at the rate of one share of Series B Preferred Stock to 10,000 shares of Common Stock; (ii) 222,969,976 shares of Common Stock issuable upon the conversion of 223 shares (the “Series E Shares”) of Series E Convertible Preferred Stock of the Issuer, par value $0.001 per share (the “Series E Preferred Stock”), which converts into Common Stock at the rate of one share of Series E Preferred Stock to 1,000,000 shares of Common Stock; and (iii) 7,077,413 shares of Common Stock issuable upon the exercise of a warrant to purchase Common Stock (the “Common Stock Warrant”). The Series B and E Preferred Stock will automatically convert into Common Stock after the Issuer amends its Certificate of Incorporation to increase the number of authorized shares of Common Stock to enable (i) all of the shares of Series E Preferred Stock to be converted at the applicable conversion number, and (ii) all shares of Series B Preferred Stock to be converted in accordance with their terms (the “Authorized Share Increase”). If the Common Stock Warrant is exercised prior to the Authorized Share Increase, the Common Stock Warrant is exercisable to purchase an equivalent amount of Series B Preferred Stock."

Pequot was founded by Art in 1986 with $3 million in assets and peaked with $15 billion in assets around the tech bubble. Today, he manages over $4 billion. They have 150 employees and employ multiple strategies, including private equity and venture capital, as Art believes equity returns will decline over time. Art holds a S.B. from Massachusetts Institute of Technology, an M.S. from Stanford University, and he received his MBA from Columbia University. Pequot Capital Management was recently ranked 93rd in Alpha's hedge fund rankings.

Taken from Google Finance,

Healthcare Services Group "provides housekeeping, laundry, linen, facility maintenance and food services to the healthcare industry, including nursing homes, retirement complexes, rehabilitation centers and hospitals located throughout the United States. Healthcare Services Group, Inc. operates in two segments: housekeeping, laundry, linen and other services (Housekeeping), and food services (Food)."

Akorn is "engaged in manufacturing and marketing of diagnostic and therapeutic pharmaceuticals in specialty areas, such as ophthalmology, rheumatology, anesthesia and antidotes, among others." is "engaged in developing an over the counter (OTC) skin care line of products called Cosmedicine. The Company launched the products in January 2006 for retail distribution at Sephora stores, Home Shopping Network (HSN), JCPenney and their respective Websites."

Hedge Fund Graveyard: 2008

Well, here's some overtly optimistic news about the hedge fund industry. That is, if you're a believer that consolidation is natural and healthy. "Only the strongest will survive."

693+ hedge funds were liquidated in the 3rd quarter of 2008 alone. That figure represents around 7% of the industry. When we first started to see signs of massive redemptions coming back in October, we knew it had the potential to get pretty ugly. It did.

Hedge funds started liquidating due to massive losses. Other funds saw huge requests for withdrawals, while others fought off investors by halting withdrawals. All in all, the damage was already done. In the fourth quarter of 2008, investors pulled out nearly $150 billion from hedge funds, or around 10% of all hedge fund assets. December marked the fourth consecutive month of outflows from hedge funds. The total net outflows for 2008 is now north of $200 billion. And, according to Channel Capital Group Inc, hedge fund performance losses for 2008 amounted to $535 billion, while $512 billion flowed through withdrawals and fund closures.

The graph below helps depict the severity of losses this year compared to the past.

(click to enlarge)

And, here are some estimated asset flows:

2008 Estimated Hedge-Fund Asset Flow Table by


Date   Total   Quarterly Quarterly  Performance   Net flows*
Assets Change % Change Losses
Q1 08 $2,847.50 ($40.16) -1.39% ($93.78) $53.62
Q2 08 $2,972.99 $125.49 4.41% $91.28 $34.21
Q3 08 $2,497.28 ($475.71) -16.00% ($347.51) ($128.20)
Q4 08 $1,841.17 ($656.11) -26.27% ($184.99) ($471.11)


Here's to hoping that 2009 can get its act together. But then again, who are we kidding... we're not necessarily counting on it.

Sources: Bloomberg, CNN, FT

Interview With Short Seller & Hedge Fund Manager Jim Chanos

Recently on twitter, I said that I had been short so much over the past year and a half that I was starting to feel like Jim Chanos. If you're unfamiliar with Chanos, he is a short-seller and manager of hedge fund Kynikos. He recently sat down with the FT to opine on the financial world. The video is available here.

Tuesday, January 27, 2009

How to Play Crude Oil Using ETFs & ETNs: A Comparison of USO, DBO, & OIL

The following is a Guest post on

'tradefast' is the nickname of an independent equity trader who has more than 20 years of market experience at a major financial institution and 2 hedge funds. He now trades for a private investment fund, using a combination of both fundamentals and technicals. (He's our kinda guy).

Last week, he sat down to explain how contango affects the crude oil ETF's and ETN's that many investors and traders usually play, including USO, OIL, & DBO. This next piece is a follow-up post to that topic. So, before beginning, make sure you check out: How Contango Affects Crude Oil ETFs & ETNs.

Next, he takes a look at how to play crude oil using those same ETFs & ETNs. He writes,


This article provides some straightforward insight as to how a retail trader/investor can implement a directional play on the price of crude oil. Included is a discussion of the manner in which the forward market for crude oil can cause crude oil ETF returns to deviate from spot market returns. This article is not intended to be authoritative, comprehensive, or highly technical. It is simply a compilation of previous discussions on the topic (with some added elbow grease and my version of common sense). Readers should be aware that much of the material in this article has been discussed previously here and here. Certain elements of this article are pulled directly from these sources.


When I first wrote about the effects of forward curves on crude oil ETFs, the crude market was in steep contango and the discussion attracted widespread attention. More recently, the crude curve has flattened somewhat and it may appear to some individuals that the curve shape has become less of an issue to retail speculators. I have a different view. I believe that sharp volatility in the shape of the curve makes it imperative that retail crude speculators understand how curve adjustments can affect their positions. This topic is not dying, but rather garnering added importance.

Introduction - Retail Investors Cannot Trade Spot Crude Oil

I have a friend with fairly extensive stock trading experience who generates most of his technical market analysis using the S&P 500 futures contract. When it comes time to transact, however, he will swing over to the cash market and trade an ETF such as SPY (S&P 500) or a leveraged ETF such as SSO (2x the S&P 500) or SDS (2x the inverse of the S&P 500 - a double short). Although he and I share the same trading objectives (to capture a directional movement in the S&P 500), I choose to generate my technical analysis using the precise instrument which I expect to trade. In my case, SPY (or SSO or SDS if I desire leverage). I am confident in my approach because I know the instrument I am trading exhibits an extremely tight relationship to movement in the S&P 500 cash market. Simply put, I trade SPY because is a highly dependable proxy for replicating the spot market of the S&P 500.

Unfortunately, traders or investors wishing to implement a directional play on crude oil lack access to a tradeable instrument which tracks spot crude oil in the same manner that SPY tracks the S&P 500. Instead, we must choose from an array of instruments which are structured with the intent of tracking crude prices, but with flaws relating to the fact that crude oil (unlike the S&P 500) is a physical commodity for which spot trading is limited to those who can transport, store, or produce crude oil.

Crude Oil Futures – The Curve

Fortunately, despite our lack of access to the crude oil spot market, there is a highly liquid market for futures contracts which reference crude oil. And, the price of these contracts exhibits volatility which generally resembles the movements in the spot market. Many traders transact directly in crude oil futures contracts, electronically or in the futures pit. These traders rely on the fact that they will never have to physically handle the commodity itself. They can simply close out their futures positions prior to expiration and net out the difference between their entry and exit price.

The fact is that trading in crude oil futures (which expire monthly) is spread out over several months, even years. And, the price of crude for delivery at future expiration often varies substantially from month to month. At times, prices in future delivery months are progressively higher than in the nearest delivery month (contango). And, more often than not, the opposite is true (backwardation). Many futures traders have specialized knowledge of the day-to-day shifts in supply and demand fundamentals and they are comfortable projecting price movements at specific points along the forward curve. The typical retail investors probably lacks the skill-set needed to profitably exploit forward curves in a sophisticated manner.

Introducing Crude Oil ETFs/ETNs

For the retail crude oil speculator who is incapable of trading crude oil futures, there are tradeable ETFs (Exchange Traded Funds) and ETNs (Exchange Traded Notes) which employ futures contracts in pursuit of the general objective of “tracking the price of crude oil”. A typical crude oil ETF will hold long positions in WTI (West Texas Intermediate) crude oil futures contracts. As with most futures traders, these funds employ leverage, putting up a small portion of the capital to buy the contracts. The rest of the fund’s assets are invested in money market instruments which generate a modest amount of interest income for the fund.

ETFs – The Roll

In theory, the existence of crude oil ETFs enable individuals to implement a single equity trade to express a view that crude oil prices will either rise or fall in the future. Unfortunately, this objective is compromised by the existence of a forward curve in the crude oil futures market.

Because of the forward Curve, any ETF referencing crude oil cannot simply rely on ownership of the existing front month (closest to expiration) futures contract. To remain invested at all times, it must periodically sell its existing futures holdings and roll its exposure to a futures contract expiring in a more distant month.

ETFs – Return Components

With crude oil ETFs, the technical result of utilizing crude oil futures for the NAV (net asset value) return is dependent on three variables: 1) changes in the spot price of crude oil, 2) interest earned on un-invested cash, and 3) the ‘roll yield’ – which is a function of the spread between the price of the contract being sold and the price of the contract being entered. In contango markets, the roll yield will be negative because the fund must pay up to enter the more distant contract, and the opposite is true in backwardated markets. Furthermore, the precise timing of the forward roll can have a material impact due to the propensity of the expiring contract to experience high volatility in the days immediately prior to expiration.

Roll Yield – ETF Return Illustration

Let us consider the case of a hypothetical crude oil ETF which provides exposure to the front month crude oil futures contract, with the exposures rolled forward as expiration approaches.

To illustrate the concept of the roll yield, assume that the 2009 spot return on crude oil is +20%. But, assume that persistent contango in the market results in a cumulative roll yield of -15 %. In these circumstances, the combined return of a crude oil based ETF might be in the ballpark of +5%, a far cry from the +20% return generated in the crude oil spot market.

As illustrated, contango in the crude oil market may cause ETF returns to lag spot market returns. Not surprisingly, a flat/stable forward curve would result in a minimal roll effect. On the other hand, a backwardated curve may cause the ETF to outperform the spot market.

Roll Yields – A Source of Tracking Error

The variability of roll yields coupled with the shifting slope of the forward curve should dispel any notion that the return on crude oil ETFs will track the spot market of crude oil in a predictable manner. The managers of the crude oil ETFs and ETNs are fully aware of this issue and they make no claims regarding their ability to replicate spot crude returns. They merely claim to attempt to track a return benchmark that is comprised of crude oil futures contracts, thereby providing traders/investors with some ability to participate in directional movements in the price of crude oil. (Note: This situation is analogous to an issue which exists with certain leveraged (non-oil) ETFs which have proven to be extremely deficient in terms of tracking their benchmark indices in volatile markets. These instruments have strictly adhered to their stated strategies and objectives, but have failed to achieve the imaginary objectives of many careless traders.)

ETFs/ETNs – Examining the Fine Print

Included below is some language directly out of the prospectuses of some of the more popular crude oil ETFs and ETNs. Notice that the managers willingly acknowledge the issues related to forward curvature and the roll yield impacts on returns. This segment of analysis will focus on the three most popular crude oil instruments in existence today: an ETN (OIL) and two ETFs (USO & DBO). Many of the issues raised herein are applicable to all crude oil ETFs and ETNs, although leveraged ETNs (such as DXO) involve complications which are not analyzed here.

ETF versus ETN – Counterparty Risk

No discussion of crude oil ETFs would be complete without some mention of the important difference between an ETF (Exchange Traded Fund) and an ETN (Exchange Traded Note). With an ETF, holders are secured by the assets of the fund, so the credit worthiness of the fund manager firm is not a relevant consideration. If the manager collapsed into insolvency, the ETF would be unaffected, except for the possibility of a change in management (which is not an important consideration in the case of a fund which is passively managed to match a specific benchmark). In contrast, owners of an ETN are unsecured creditors who receive a mere ‘promise to pay’ equivalent to the value of the underlying assets. Let's simplify this distinction: If a given ETF and a given ETN have the same exact net asset value (NAV), it is conceivable that the ETN could be worth less than the ETF if the manager of the ETN asset pool experienced a level of financial distress which resulted in a material downgrade of the credit quality of the manager’s bonds. Given that most ETN managers are financial institutions with challenging balance sheets, this risk is worthy of consideration.

In a worst case scenario, the ETN manager could face an abrupt insolvency and default on the ETN. This risk, often referred to as counter party risk, is similar to the risk that credit default swap (CDS) holders faced when Lehman Brothers and AIG encountered insolvency. We, as rational individuals, do not buy insurance from high risk insurers. And, as such, we should think similarly about owning ETNs issued by high risk managers.

US Oil Fund (USO)

USO is a standard crude oil tracking ETF that utilizes a strategy resembling the hypothetical ETF analyzed earlier in this article. Accordingly, USO entails all of the risk factors related to the use of crude oil futures as a tracking mechanism for crude oil prices. As with all ETFs, the objectives, the portfolio structure, and the major risk factors are clearly disclosed in the prospectus.

From the ‘risk factors’ section of the USO prospectus,

"in the event of a crude oil futures market where near month contracts trade at a lower price than next month contracts, a situation described as ‘‘contango’’ in the futures market, then absent the impact of the overall movement in crude oil prices the value of the benchmark contract would tend to decline as it approaches expiration. As a result the total return of the Benchmark Oil Futures Contract would tend to track lower. When compared to total return of other price indices, such as the spot price of crude oil, the impact of backwardation and contango may lead the total return of USOF’s NAV to vary significantly. In the event of a prolonged period of contango, and absent the impact of rising or falling oil prices, this could have a significant negative impact on USOF’s NAV and total return."

Notice how they warn that USO may experience a negative roll yield which may cause the NAV of USO to deviate significantly from the spot price of crude oil. Is there historical precedence for USO deviating from spot oil by a material amount? As it turns out, the answer is ‘yes.'

"During the past two years, including 2006, these markets have experienced contango. This has impacted the total return on an investment in USOF units during the past year relative to a hypothetical direct investment in crude oil. For example an investment made in USOF units on April 10 and held to December 31, 2006 decreased, based upon the changes in the closing market prices for USOF units on those days, by 23.03%, while the spot price of crude oil for immediate delivery during the same period decreased 11.18%."

The only logical conclusion is that USO is not a direct play on the spot price of crude oil. It is, instead, a play on the spot price, forward prices, and the relationship between spot and forward (or, the slope of the futures curve).

Power Shares DB Oil Fund (DBO)

DBO is different from USO in that its managers utilize specialized strategies intended to mitigate the effect of roll yields on returns. As with USO, the prospectus for DBO directly addresses the issue of roll risk. In the case of DBO, however, the manager is not passive about accepting a negative roll yield in a contango market. In the words of the manager,

"Rather than select a new futures contract based on a predetermined schedule (e.g., monthly), each Index Commodity rolls to the futures contract which generates the best possible ‘implied roll yield.’... [The manager] is able to potentially maximize the roll benefits in backwardated markets and minimize the losses from rolling in contangoed markets."

I think it is fair to point out that the active approach being utilized by DBO presents both opportunities and risks in relation to the more passive rule-based approach used by USO. It is certainly conceivable that, by employing their optimization model, DBO will exhibit improved roll yields and better returns than USO. But, as with all things financial, the DBO model may backfire due to faultiness of imbedded assumptions. If DBO’s approach were full-proof, it is probably fair to conclude that an arbitrage opportunity might exist whereby profits could be generated by pairing a long position in DBO with a short position in USO. At this juncture, I am extremely hesitant to advocate such a strategy. Advanced readers wishing to gain a better understanding of DBO’s optimization approach may benefit from this link.

IPath S&P GSCI Crude Total Return ETN (OIL)

OIL is structured as an ETN issued as an uncollateralized obligation by Barclays Bank PLC. It is a financial institution that can be regarded as vulnerable to rising default risk in the current environment. As with USO and DBO, OIL is managed with the objective of tracking WTI crude oil prices by trading in crude oil futures (rather than the physical commodity).

OIL uses a specific benchmark to guide its futures trading activity: a crude oil index devised by Goldman Sachs. As with most index funds, OIL’s objective is to minimize the performance tracking error in relation to the index. OIL is not intended to perform better or worse than the index. The composition of the index, by design, can include any of the crude oil futures contracts which expire within three months. At present, however, the only contract used to calculate the index is the front month contract (which expires three business days prior to the 25th of the next calendar month).

OIL’s roll strategy is formulated and it is unique from that of DBO and USO. But, the differences in relation to USO probably do not have a material economic effect. In particular, holdings of the front month futures contract are rolled over a five day period commencing on the fifth business day of the month. Essentially, this means that OIL will have completed its roll approximately two weeks before front month expiration. (Note: USO rolls two weeks prior to expiration).

In essence, OIL is more similar to USO because the roll strategy is formulaic, and not intended to minimize the effects of negative carry in a contango futures market (or maximize the benefits of backwardation). But, this similarity is also offset by the fact that OIL carries material counterparty risk since it is an ETN, while USO and DBO do not (since they are ETFs).

USO Versus DBO Versus OIL - Expenses and Liquidity

The volatility of these instruments is so high that expenses have a relatively minimal impact. But, for frugal and/or longer term investors, the following information may be relevant:

Annualized expense ratios:

  • USO 0.86%
  • DBO 0.54%
  • OIL 0.75%

Empirical Data – Historical Price Returns

It is unwise to draw any specific conclusions from this information, but a quick examination of the recent market returns of USO, DBO, and OIL reveal the following facts:

Year-to-date price returns (thru 1/24/09):

  • USO -2.9%
  • DBO +1.1%
  • OIL – 7.9%

Although inconclusive, the material disparity between the return of USO and OIL is potentially due to the fact that OIL is an ETN issued by Barclays – a Bank that has suffered from extensive credit quality impairment in recent days.

Returns, 2008 peak to current:

  • USO -72%
  • DBO -65%
  • OIL -75%

Further assessment of the relative returns of these instruments can be found here.


Considering the following factors:
  1. Counterparty risk
  2. Futures roll strategy (and roll yield)
  3. Liquidity and expenses

USO has no counterparty risk and no active management risk. DBO has no counterparty risk but has inherent risks and opportunity related to the active management of the roll. Lastly, OIL has material counterparty risk. I currently favor USO as the instrument to express my directional views on crude oil over the other two instruments DBO and OIL.

Thanks to 'tradefast' for the excellent in-depth overview of crude oil ETFs & ETNs. We think he has highlighted some excellent points that any trader or investor should know before using these vehicles to speculate on crude oil. If you haven't already, make sure you check out: How Contango Affects Crude Oil ETFs & ETNs. For additional coverage on crude oil, check out the recent slide presentation: Cheap Oil = Over. Also, we've commented on cheap oil, and have covered energy trader Eric Bolling's latest oil trades and thoughts here.

Lastly, you can follow tradefast on Twitter, and catch his thoughts on his blog.

Tudor Investment Corp (Paul Tudor Jones) Files 13D's

Paul Tudor Jones' hedge fund Tudor Investment Corp has filed 2 separate amended 13D's with the SEC. Firstly, Tudor has disclosed a 19.4% ownership stake in Uni-Pixel (UNXL). This stake is derived from their ownership of 769,974 Series B Convertible Preferred Stock (which are convertible into 3,849,870 common stock shares), as well as 1,645,647 warrants to purchase common stock. They currently own 5,495,517 shares. The filing was made due to activity on December 31st, 2008. You can view the rest of Tudor's portfolio holdings here.

Secondly, Tudor also disclosed a 12.9% ownership stake in Incentra Solutions (ICNS). They currrently own 3,320,203 shares of common stock and 903,994 shares of Series A Preferred Stock that, if converted, would give them 2,711,982 additional shares of common stock.

About Tudor: Taken from Wikipedia, the bio of PTJ is as follows, "In 1980 he founded Tudor Investment Corporation which is today a leading asset management firm headquartered in Greenwich, Connecticut. The Tudor Group, which consists of Tudor Investment Corporation and its affiliates, is involved in active trading, investing and research in the global equity, venture capital, debt, currency and commodity markets. One of Jones' earliest and major successes was predicting Black Monday in 1987, tripling his money during the event due to large short positions. Jones uses a global macro strategy when trading in some of his funds. This strategy can be seen in the 1987 PBS film "TRADER: The Documentary". The film shows Mr. Jones as a young man predicting the 1987 crash. Jones' firm currently manages$17.7 billion (as of June 1, 2007). Their investment capabilities are broad and diverse, including global macro trading, fundamental equity investing in the U.S. and Europe, emerging markets, venture capital, commodities, event driven strategies and technical trading systems." So, as you can see, PTJ is quite an accomplished gentleman, earning him the title of the macro trader. If you want to hear some insightful thoughts from Paul Tudor Jones himself, head over to our post on Hedge Fund manager interviews or our post on quotes from PTJ. Tudor's 13F filing disclosing their portfolio positions can be found here.

Taken from Google Finance,

Incentra Solutions is "a provider of information technology (IT) services and solutions to enterprises and managed service providers in North America and Europe. Solutions offered by the Company include hardware and software products, maintenance contracts, professional services, recurring managed services and capital financing solutions."

Taken from their company website,

UniPixel "intends to become the core developer and licensor of the highest performance and most efficient display panel technologies in the industry. These display panel technologies will enhance the application devices to which they are incorporated delivering superior results to the end users of the devices."

Carlos Slim Discloses 16.21% Stake in New York Times (NYT)

Amongst all the reports that Carlos Slim's companies were going to give the New York Times (NYT) $250 million at (crazy) 14% interest, we finally get a raw number as to his position in the company. In a 13G filed with the SEC, Carlos Slim has disclosed a 16.21% stake in NYT with 25,754,000 shares of class A stock.

This adds to his investment arsenal of a 17.8% stake in Saks, and a 7.64% stake in Bronco Drilling, among other things.

Carlos Slim is a well-known Mexican businessman who amassed his wealth through telecom. He is known for his association with America Movil (AMX), Telcel, and Telefonos de Mexico (TMX) and was the second richest man in the world as of 2008. Slim has been busy in the markets recently.

Taken from Google Finance,

The NYT is "is a diversified media company, including newspapers, Internet businesses, television and radio stations, and investments in paper mills and other investments."

Disclosure: market folly was short NYT at the time of writing. Holdings can change at any time.

Monday, January 26, 2009

Portfolio Update on David Einhorn's Greenlight Capital

This update does not come from various SEC filings, but rather from their latest investor letter. In it, we learn that hedge fund Greenlight Capital's top five long equity positions were Allegheny Energy, Arkema, Criteria Caixa, Österreichische Post, and URS Corp. They had an average exposure of 76% long and 37% short. During the last quarter, they sold out of their long position in Ameriprise Financial. Additionally, they covered the following short positions: American Reprographics, Aurelian Resources (Canadian), Equinix, Great Atlantic & Pacific Tea, Itron, Macquarie Airports (Australian), and McGraw-Hill.

And, they also added some new long positions in the last quarter. These additions include: Allegheny Energy (AYE), Commscope (CTV), MEMC Electronic Materials (WFR), gold and an index of gold miners (GDX), and the Japanese Yen. Additionally, they mention that they were buying bank debt, high yield bonds, convertible bonds, gold, select foreign currencies, and equities. Its also interesting to note that Greenlight was short Volkswagen and got caught up in the massive short squeeze, which they detail in the letter. 2008 was the first year they have lost money since opening in 1996.

We've previously covered Greenlight's portfolio holdings, as well as their performance numbers. Also worth checking out is Einhorn's book, where he details his battle shorting Allied Capital. In it, you learn about Greenlight's theses formation and investment process: Fooling Some of the People All of the Time.

You can read their investor letter in its entirety here (.pdf) courtesy of Zero Hedge.

Greenlight is a $6 billion fund ran by David Einhorn and has seen annual returns of over 20%. Greenlight specializes in spin-offs and value investing. Einhorn's name has been popping up in the media a lot over the past year, as he talked about his well documented short position in Lehman Brothers (LEH). And, while that position paid off handsomely for him, it barely offset losses he experienced from other positions.

Bill Ackman's Pershing Square Files 13D on Borders, Covers MBIA Short

Pershing Square Capital Management, the hedge fund ran by Bill Ackman, has filed an amended 13D with the SEC and has disclosed a 33.62% ownership stake in Borders (BGP). According to the filing,

"As of January 16, 2009, as reflected in this Amendment No. 9, the Reporting Persons are reporting beneficial ownership on an aggregate basis of 25,297,880 shares of Common Stock (approximately 33.62% of the outstanding shares). This includes warrants covering 14,700,000 shares of Common Stock, which represents 9,550,000 warrants received on April 9, 2008 and 5,150,000 warrants received on October 1, 2008 (each, as previously disclosed). The Reporting Persons own cash settled, total return equity swaps covering 4,805,463 notional shares of Common Stock (as previously disclosed). The notional shares that underlie such swaps are not included in the totals set forth in the charts earlier in the Schedule 13D. The aggregate economic exposure of the Reporting Persons to shares of Common Stock, including the aggregate shares of Common Stock beneficially owned by the Reporting Persons plus the aggregate notional shares underlying such swaps, represents approximately 40% of the sum of the outstanding shares of Common Stock and the shares of Common Stock underlying such warrants. "

Additionally, Pershing has "extend the deadline for repayment of the $42,500,000 senior secured term loan" that is owed to them by Borders. The full text of the arrangement (a.k.a. fun legal jargon) is available in the SEC filing.

Also worth noting is that Ackman's Pershing Square has covered his short position in bond insurer MBIA (MBI). They have closed their short position and sold their credit default swaps. This ends a long and well documented battle between the two parties.

We've recently covered Ackman's recent SEC filings here and the rest of his portfolio holdings here.

Taken from Google Finance,

Borders "through its subsidiaries, operates book, music and movie superstores, and mall-based bookstores. The Company's operating subsidiaries include Borders, Inc. (Borders), Walden Book Company, Inc. (Waldenbooks) and Borders Australia Pty Limited. As of May 3, 2008, the Company operated 547 superstores under the Borders name."

MBIA is "engaged in providing financial guarantee insurance and other forms of credit protection, as well as investment management services to public finance and structured finance issuers, investors and capital market participants on a global basis."

Warren Buffett Talks About Buying Back BRK.A Stock

Here's Buffett's interview with PBS, where he discusses possibly buying back Berkshire Hathaway (BRK.A) stock.

Also, we wanted to pass along a nice collection of past Buffett columns. Like the recent Warren Buffett is Buying American column, these .pdf's take you back through similar columns he has written during periods where stocks looked attractive to him.

And, lastly, don't forget to check out The Snowball: Warren Buffett and the Business of Life by Alice Schroeder. She was hand picked by Buffett to be his biographer and this is the result. Snowball turns you upside-down and inside-out within the world of all things Buffett. I recently read this and enjoyed it immensely.