Excerpt From Howard Marks' Book: The Most Important Thing Illuminated

Today we have a special treat for readers as we've been granted permission to publish an excerpt from the book written by Oaktree Capital's Chairman, Howard Marks.

Marks' book, The Most Important Thing Illuminated (or Kindle e-book version here) features a section on combating negative influences, which we've excerpted below:

"People who might be perfectly happy with their lot in isolation become miserable when they see others do better.  In the world of investing, most people find it terribly hard to sit by and watch while others make more money than they do.

Howard Marks: Emotion and ego: A lot of the drive in investing is competitive.  High returns can be unsatisfying if others do better, while low returns are often enough if others do worse.  The tendency to compare results is one of the most invidious.  The emphasis on relative returns over absolute returns shows how psychology can distort the process.

I know of a nonprofit institution whose endowment earned 16 percent a year from June 1994 to June 1999, but since its peers averaged 23 percent, the people involved with the endowment were dejected.

Seth Klarman: Even the best investors judge themselves on the basis of return.  It would be hard to evaluate yourself on risk, since risk cannot be measured.  Apparently, the risk-averse managers of this endowment were disappointed with their relative returns even though their risk-adjusted performance was likely excellent, as borne out by their performance over the following three years.  This highlights just how hard it is to maintain conviction over the long run when short-term performance is considered poor.

Without growth stocks, technology stocks, buyouts and venture capital, the endowment was entirely out of step for half a decade.  But then the tech stocks collapsed, and from June 2000 to June 2003 the institution earned 3 percent a year while most endowments suffered losses.  The stakeholders were thrilled.

There's something wrong with this picture.  How can people be unhappy making 16 percent a year and happy making 3 percent?  The answer lies in the tendency to compare ourselves to others and the deleterious impact this can have on what should be a constructive, analytical process.

Joel Greenblatt: This is incredibly important.  Most institutional and individual investors benchmark their returns, and therefore most end up chasing the crowd: accent on the wrong sylLABle."

Excerpted from, The Most Important Thing Illuminated by Howard Marks.  Copyright (c) 2012 Howard Marks.  Used by arrangement with Columbia University Press.  You can also get the Kindle e-book version here.


His book is definitely a must-read so check it out.  And if you missed it, we also posted up Marks' recent commentary on contrarian signals.

Corsair Capital's Investment Thesis on SunCoke Energy (SXC)

Earlier today we posted up Corsair Capital's Q1 letter.  Now, we present their investment thesis on one of their latest positions: SunCoke Energy (SXC).  SXC was spun-off from Sunoco last year and the hedge fund thinks investors misunderstand the company's business model.

Corsair believes that "SXC offers both steelmakers and equity investors a compelling and valuable proposition.  SXC has modest debt, generates a tremendous amount of cash, and management has invested in SXC since the spin.  At 10x 2012 run rate EBITDA less Maintenance CapEx ... we derive a target price over $25."

That's some compelling upside seeing how SunCoke Energy currently trades around $14.  Corsair says that one of the main things that attracted them to invest was SXC's highly-structured contracts, recurring cashflows, and incremental (low-risk) earnings growth.

The hedge fund also sees growth opportunities as compelling as well as the potential to convert coke operations to an MLP structure.

However, the main risk here is that Arcelor Mittal (MT) accounts for 70% of the company's sales and they only have three primary customers.

As far as valuation goes, Corsair writes:

"Based on $300 million of EBITDA (2012 guidance plus Middletown for a full year of operations) less Maintenance CapEx of $60 million valued at 10x yields a target price of $27."

Embedded below is Corsair's investment thesis on SunCoke Energy:



Be sure to also read the rest of Corsair Capital's Q1 letter for updates on their other investments.

Corsair Capital Provides Updates on Their Positions: Q1 Letter

Jay Petschek and Steven Major's hedge fund Corsair Capital is out with their Q1 letter and in it they detail updates on their investments in: LyondellBasell (LYB), Shaw Group (SHAW), Republic Airways (RJET), Neo Material Technologies (NEM) and TNS (TNS).

Given that LYB has been owned by numerous hedge funds, we wanted to highlight their commentary:

LyondellBasell (LYB) - "Though the company reported a weak Q4 as expected, the market anticipates record-low gas prices will continue to suppress ethane prices, one of LYB's main input costs, thereby supporting high ethylene margins.  If current ethane prices are sustainable, the industry could enter a 'super-cycle' where LYB would show earnings previously not thought possible.  The company also took advantage of the current strong credit markets and refinanced $3 billion of debt, benefitting by both extending maturities and lowering interest payments."


Also, the fund addressed their position in Shaw Group (SHAW): "two of its main customers received the final requisite Nuclear Regulatory Commission licensing to construct two new nuclear power plants and the EPA's increased environmental standards drove power plant maintenance contract wins.  The company also reported a strong fiscal Q2 and the upcoming divestiture of the Energy and Chemicals division in the next few months should create additional shareholder value.  We estimate that SHAW could earn $3.00/share in FY 2013, which would increase its net cash position to over $17.00/share."

We've previously posted up Corsair's investment thesis on Shaw Industries for further color.



Embedded below is Corsair Capital's Q1 letter:



Later this morning we also posted up Corsair's investment thesis on SunCoke Energy.

What We're Reading ~ 4/26/2012

Compliance: a marketing edge [FINalternatives]

Keynes: one mean money manager [WSJ]

Financial sleuth Howard Schilit back on the job [Barron's]

Schilit's great book: How to Detect Accounting Gimmicks & Fraud [Amazon]

The investment checklist manifesto series [Research Puzzle]

Jim Chanos to speak in Milwaukee [Make A Difference] 


Is Yale's Endowment the new Tiger Management? [aiCIO]

Why do value investors underperform? [Greenbackd]

Finding alpha in Israel's emerging market [AllAboutAlpha]

Hedge fund ads are a gamechanger [Marketwatch]

Bill Ackman & Sam Zell on turnarounds, opportunities & success [IBTimes]

John Maynard Keynes: star investor? [CXO Advisory]

Business troubles deepening at The New York Times? [Poynter]

An investment checklist [Portfolio14]

On Jesse Livermore & his legacy [MarketThoughts]

Hedge fund managers a gloomier lot in 2012 [Reuters]

East Coast Asset Management on Mispricings: Q1 Letter

Christopher Begg's East Coast Asset Management is out with their first quarter letter and in it they focus on mispricings.  We like to highlight their letters due to the focus on investment process.  After all, investing is a profession that requires continual education.

Begg shares his wisdom by writing, "Mispricing discovery is intelligent investing. We want to clarify that mispriced does not mean cheap - mispriced investments are not partial to any particular asset class nor are they partial to style boxes and growth rates."

We've previously highlighted how Greenlight Capital's David Einhorn looks for mispricing when investing, seeking to better understand situations to generate returns.

Begg goes on to breakdown mispricings into two types:

Structural - These exist "when an event occurs that forces a large population of owners to sell without any change in the investment's intrinsic value.  Examples of structurally induced selling would include: when an investment is deselected from an index, when a company is spun off from a larger parent company, or perhaps when a company's credit rating is reduced."

Psychological - He says that these mispricings "are driven from collective investor psychology which induces broad selling or a lack of buying in an investment."

East Coast feels that "our greatest source of mispricings occurs when myopic investors have difficulty focusing on the distant compounding merit of a great business (compounder category) or the inflection point of a material change in an industry that is improving (transformation category)."

Begg then goes on to highlight their investment in Colgate-Palmolive (CL) as a prime example.


Current Market Commentary

East Coast also summarizes their views on the current market, writing

"In aggregate, the market is reasonably priced at below 14 times 2012 projected earnings; inverting the multiple means that we are getting a 7.5% earnings yield.  If we include an economic growth rate of 2-3% we arrive at expected equity returns in high single digits."

Their letter also goes on to examine Apple (AAPL), concluding that, "We don't disagree with the quality of the business nor do we doubt that the valuation looks attractive.  What we do struggle with is the ability to truly compound at an attractive rate based on size."  We've also posted up on the subject with our post: The Apple Conundrum.

Embedded below is East Coast's first quarter letter:



For more from this firm, head to East Coast on embracing uncertainty as well as their great piece on gaining an investment edge.

Glenview Capital Buys More Health Management Associates (HMA)

Larry Robbins' hedge fund firm Glenview Capital filed a new 13G with the SEC regarding its position in Health Management Associates (HMA). Per the filing, they now own a 5% stake in the company with 12,824,276 shares.

This is an increase of 148% in their position size since the end of 2011 and the new filing was made due to activity on April 13th. This isn't the only health-related play Glenview's been buying as of late. They also started a position in Tenet Healthcare.

Per Google Finance, Health Management Associates is "by and through its subsidiaries operates general acute care hospitals and other health care facilities in non-urban communities. As of December 31, 2011, the Company operated 66 hospitals with a total of 10,330 licensed beds in Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Missouri, North Carolina, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Washington and West Virginia."

In other portfolio activity from this hedge fund, we've highlighted how Glenview boosted its stake in Mueller Water Products.

SAC Capital Trims Annie's Stake

Steve Cohen's hedge fund firm SAC Capital just filed an amended 13G with the SEC regarding its position in Annie's (BNNY). Per the filing, SAC now owns a 4% ownership stake in the company with 670,500 shares.

This is a slight decrease in their stake. We previously highlighted SAC's original stake in Annie's just a few weeks ago. Since then, they've sold almost 17% of their position.

Annie's recently completed its IPO and shares are up just over 9% in the open market. The big gains stem from the IPO itself when BNNY priced at $19 per share and gained 89% on its first day of trading, an event SAC almost certainly participated in.

SAC's filing was made due to portfolio activity on April 11th.

Per Google Finance, Annie's is "a natural and organic food company offering consumers products in packaged food categories. The Company sells its products in three product categories: meals; snacks; and dressings, condiments and other."

Steve Cohen was recently named one of the top 25 highest earning hedge fund managers of 2011.

JANA Partners Discloses Barnes & Noble (BKS) Stake

Barry Rosenstein's event-driven hedge fund JANA Partners filed a Form 3 with the SEC regarding shares of Barnes & Noble (BKS). Per the filing, the hedge fund has revealed almost a 7 million share position in BKS.

This is a brand new position for JANA as they did not own shares at 2011 year-end. BKS was up over 18% today as investors speculated the activist investor would push the company to split up. After all, JANA recently pushed for McGraw-Hill to split up.

However, the hedge fund has only filed a passive 13G with the SEC at this time, disclosing their 11.6% ownership stake in the company. If they were pursuing activism, they would have filed a 13D.

In the Form 3, JANA also disclosed "put options (obligation to buy)" representing 250,000 shares with an exercise date of May 18th, 2012 and a strike price of $13. We've quoted the above from the filing because it's caused a bit of confusion.

In the traditional definition of buying options, puts are the right, but not obligation, to sell shares. They've written "obligation to buy" instead on the Form 3. So, this could mean 1 of 2 things: they either sold the puts or they meant to write "calls (obligation to buy)."

Both are essentially bullish bets so it's just technicalities. We've sent an inquiry to JANA.

If they sold puts, that means they're more than likely willing to buy more shares at the $13 pricepoint. This would be the first time we've ever seen a fund disclose the sale of options, as usually they only disclose when they purchase calls or puts.

And if they actually bought calls, they most likely bought them when they were out of the money (due to the $13 strike). On the big surge today due to the news of JANA's stake, these calls (if that's what they meant) are now in the money. We hope to get clarification from them about this, but either way it seems to be a bullish wager.


BKS Top Holders

This is an interesting shake-up in terms of ownership stakes. Billionaire Ron Burkle owns a sizable stake in BKS, as does John Malone's Liberty Media (LMCA). (Interestingly, JANA also owned a chunk of LMCA shares as of the end of 2011).

Almost a year ago, Liberty made an offer to acquire BKS for $17 per share in cash, but the two eventually settled on BKS selling Liberty $204 million in convertible preferred bonds.

Other top hedge fund holders of BKS on record as of December 31st, 2011 include Balyasney Asset Management and Citadel.

Conversely, Mick McGuire's Marcato Capital had previously disclosed a sizable put position in Barnes & Noble. Whitney Tilson's T2 Partners has also been short BKS.


Bulls Versus Bears

The bulls point to Barnes & Noble's Nook e-reader segment as attractive. Some analysts believed that's what John Malone's company targeted in the first place and others have postured that JANA might push for a split up of the company.

Bears obviously point to the fact that it's no secret physical booksellers are facing heat in the form of a) competition from cheaper prices from Amazon.com (AMZN) and b) the digitilization of the publishing industry as books convert into e-books.

Barnes & Noble's primary brick and mortar competitor in this arena, Border's, filed for bankruptcy. BKS is looking to avoid the same fate and it looks like some investors are eying the e-book segment.

It will be interesting to see what happens given that BKS has been a favorite short of various hedge funds, but you also have potential activists involved (JANA) and potential buyers that have demonstrated their interest (Liberty) on the long side.

For more of our coverage of this hedge fund, head to JANA's presentation on MHP.

Global Hedge Fund Assets Hit $2.059 Trillion

Hedge Fund Intelligence is out with an interesting report on hedge fund assets. In it, they find that overall assets increased in 2011. Despite the fact that the median performance of hedge funds in 2011 was -2.01%, the industry still saw net inflows.

At $2.059 trillion in assets, hedge funds still have yet to re-conquer the peak in assets reached in 2007 of over $2.5 trillion.

According to the release, "The US market remains very much the top location for the world's biggest hedge fund firms. There are currently 230 firms that manage hedge fund assets of $1 billion or more from the US."

Embedded below is the global hedge fund assets report:



For more stats, see also the top 10 hedge funds by net gains since inception as well as the top 25 highest earning hedge fund managers of 2011.

Jeremy Grantham on Betting Against Bull Market Irrationality

GMO's Jeremy Grantham is out with his latest quarterly letter. In it, he talks about how to bet against bull market irrationality. He also touches on the tension between protecting your job or your clients' money. He also says that investment managers, in order to not lose their jobs, must "never, ever be wrong on your own."

On how most investors prevent this, Grantham goes on to write:

"Professional investors pay ruth­less atten­tion to what other investors in gen­eral are doing. The great major­ity 'go with the flow,' either com­pletely or par­tially. This cre­ates herd­ing, or momen­tum, which dri­ves prices far above or far below fair price."

Herding in the markets is by no means a new phenomenon. Legendary investor Michael Steinhardt last year said that there's more herding in hedge funds than ever.

Grantham then goes on to re-phrase the oft-quoted Keynes reference of "the market can stay irrational longer than the investor can stay solvent" to an amended version that ends with "longer than the client can stay patient."


How to Survive Betting Against Bull Market Irrationality

Grantham lays out 3 main ways to do so:

1. Invest with a margin of safety: This, of course, is one of the principles by which Seth Klarman and many other value investors invest. The last two days we've highlighted notes from Seth Klarman's Margin of Safety.


2. Stay reasonably diversified: For a retail investor, this can make sense. However, we'd imagine that numerous hedge funds would disagree with this statement.

Many long/short managers often run portfolios of around 20 long positions and 30-40 short positions. Their argument would be that in lieu of diversification as a means to protect from downside, they've outright hedged by shorting. But then again, it all comes down to Grantham's definition of just how diversified 'reasonably diversified' is.


3. Never use leverage: Leverage has been the demise of many investors, so this is prudent advice. While some hedge funds employ leverage, the ones who do so successfully seemingly keep it to low levels. It's when you're leveraged 30:1 (or whatever Lehman Brothers was at) that problems arise.

Embedded below is Jeremy Grantham's latest investment outlook:



For further wisdom from the strategist, head to Grantham's 10 investment lessons.

What We're Reading ~ Tech Edition 4/20/12

Time for another quick tech sector edition of our linkfest. The usual hedge fund/market links will continue to be posted every Wednesday.

The Facebook IPO Primer [Nancy Miller]

Contrarian call: Sell AAPL [SumZero]

See also: the AAPL conundrum [Market Folly]

The next hedge fund trade: social media [Barron's]

The future of wireless is wired [Forbes]

Jeff Bezos' annual letter to shareholders [Amazon]

What Amazon's ebook strategy means [Charlie's Diary]

What will happen to Research in Motion: 4 possibilities [ReadWriteWeb]

DirecTV seeks strategy with advancing stock aided by cash [WashingtonPost]

Bank street perspective on the AboveNet deal [Telecom Ramblings]

How Grand Theft Auto changed video games [Cnet]

Carriers warn of crisis in mobile spectrum [NYTimes]

Summary of Yahoo's earnings conference call [AllThingsD]

What is Apple worth? [Stock Sage]

10 things we learned about Apple this year [SplatF]

Smartphones and the revenge of the phone carriers [BusinessWeek]

Goldman Sachs Recommends Staying Long Equities & Buying the Dips

Goldman Sachs' Investment Strategy Group recently reviewed four areas they're watching in regards to the markets and economy. In a research note, they address:

1. The current US trajectory: While they do not project growth above the natural trend, they do believe the country is on a sustainable, slow & steady trajectory.

2. Equity valuations: Goldman uses numerous metrics to measure valuation such as 10-year cash flow, price to book, and price to trend earnings. Using a combination of those, they believe equities are fairly valued. They outline two key questions: are margins at risk of declining? And do earnings have to follow suit and decline as well? They feel that margins will be sustained.

3. Geopolitical and other risks: They highlight Middle East tension, renewed pressures in the European periphery, as well as a hard landing in China as key risks. On the last issue, we've posted up Dan Arbess versus Jim Chanos on whether China is a bubble or bonanza. Goldman outlines a combination of these risks accounting for a 25% downside probability in US markets.

4. The merits - or lack thereof - of the old adage, "Sell in May, and go away": Goldman's team identified statistically significant weakness in the month of September. But historically, they point to positive returns in May through August. The main takeaway here is that if the market is down in September, it has typically gone down a lot. That said, they found no evidence to support a consistent "sell in May and go away" investment strategy.


Goldman's Investment Conclusion

Their Investment Strategy Group writes,

"While the economic backdrop, neutral valuations, and moderate geopolitical and economic risks favor equities in our opinion, we also recognize that investing in equities entails volatility. As an asset class with 15% annual volatility, it is typical for equities to decline by 5% or more about 3 times a year and 10% or more about once a year, on average. So to capture the upward trend in equities, an investor has to tolerate the frequent downdrafts. The latest non-farm payroll and heightened concerns about peripheral Europe might well result in one of these downdrafts; in fact, our very short-term momentum signals have turned negative. But as investors - rather than traders - we recommend staying long equities. For those who are underinvested, we recommend using downdrafts as opportunities to build equity positions."

For additional market commentary, head to strategist Jeff Saut's latest note on being conservative, not conventional.

Pershing Square Disposes Of J.C. Penney Total Return Swap

Bill Ackman's Pershing Square Capital just filed a form 4 with the SEC regarding a total return swap on J.C. Penney (JCP). On April 13th, they disposed of a total return swap with a conversion/exercise price of $34.15 that represented 602,600 underlying shares.

Due to the terms of the swap with the counterparty, Pershing netted the difference between the expiration price of $34.15 and the $29.29 reference price as established by the swap. Hedge funds often utilize total return swaps to ramp up leverage. We've previously highlighted when Pershing bought total return swaps late last year.

Here's the fine print from the filing:

"Under the terms of the cash-settled total return swap (i) Pershing Square International was obligated to pay to the bank counterparty any negative price performance under $29.29 per share for each of the 602,600 notional number of shares of Common Stock subject to the swap as of the expiration date, plus interest at the rates set forth in the contract, and

(ii) the bank counterparty was obligated to pay to Pershing Square International any positive price performance above $29.29 per share for each of the 602,000 notional shares of Common Stock subject to the swap as of the expiration date. Any dividends received by the counterparty on such notional shares of Common Stock during the term of the swap were to be paid to Pershing Square International as of the expiration date of the swap. At the time of the expiration of the cash-settled total return swap, the price of the reference security was $34.15 per share. All balances have been settled in cash.

As to why the swap was disposed, the fine print reads:

"The swap terminated in accordance with its own terms on April 13, 2012 without action on the part of the Reporting Persons, and, on such date, the Reporting Persons were unable to enter into replacement positions due to regulatory restrictions and the issuer's compliance restrictions. The Reporting Persons may in the future replace the expired swap, subject to any regulatory restrictions, the issuer's compliance restrictions, and any market conditions that may exist at that time."

You can read about Ackman's thesis on JCP here.

And for more recent activity from this investor, head to Ackman's presentation on Burger King.

John Paulson Sells More Delphi Automotive (DLPH)

John Paulson's group of hedge funds at Paulson & Co just filed a Form 4 with the SEC regarding its position in Delphi Automotive (DLPH). We previously highlighted how Paulson was selling DLPH and he's at it again.

Per the filing, Paulson & Co was out selling DLPH shares on April 16th through 18th. In total, all their various entities sold just over 3 million shares.

As a reference point, the fine print says that Paulson's Enhanced Ltd owns 11.6 million shares, Recovery Master owns 3.3 million, Enhanced LP owns 2.9 million, International owns 3.9 million, Advantage Master owns 877,223 shares, Advantage Plus Master owns 1.4 million, and Paulson Partners owns just over 1 million shares.

In other recent portfolio activity, we've pointed out that Paulson keeps buying NovaGold Resources.

Seth Klarman Interview With Charlie Rose

A few months back, Charlie Rose interviewed Baupost Group's legendary investor Seth Klarman. Just yesterday, we posted up notes from Seth Klarman's Margin of Safety so we figured this was a very appropriate follow up.

The video interview starts with talk about his nonprofit "Facing History" for the first 18 minutes or so. After that, they shift topics to Klarman's book, Margin of Safety.

One interesting tidbit from the conversation is when Klarman contrasted his investing style to that of Warren Buffett's. Baupost's leading man says that he buys "cigar butts" at cheap prices. Warren Buffett used to also do this. The difference between the two legends is that Klarman stayed focused on cigar butts while Buffett's process morphed into buying great companies at great prices and then into paying so-so prices for great companies.

Appearances and interviews by Klarman in public are rare, so needless to say this is a must-watch. Embedded below is Charlie Rose's interview with Seth Klarman:



If you missed it, be sure to check out notes from Seth Klarman's Margin of Safety.

Notes From Seth Klarman's Margin of Safety

Thanks to a reader for sending us the following notes from Seth Klarman's famous book, Margin of Safety. Written by Ronald Redfield, these notes provide a great summary of Klarman's book for those of you who don't want to pay $1,000 for a now out-of-print copy.

Why should you care about this? Well, for those of you who are unfamiliar, Klarman's Baupost Group is one of the top 10 hedge funds by net gains since inception. And since numbers do the talking in the investing world, it's time to pull up a chair and learn from the best.


Redfield singles out prudent quotes from Klarman such as this gem on risk:

"Targeting investment returns leads investors to focus on potential upside rather on downside risk ... rather than targeting a desired rate of return, even an eminently reasonable one, investors should target risk."

And by focusing on risk, Klarman of course hints that investors should seek a margin of safety in their investments. He goes on to specifically address this topic, writing:

"A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world."

Redfield points out that Klarman says investors can battle risk via diversification, hedging, and investing with a margin of safety.

Klarman also touches on other tricky aspects of investing, such as forced selling. He writes, "The trick of successful investors is to sell when they want to, not when they have to. Investors who may need to sell should not own marketable securities other than U.S. Treasury Bills."

John Burbank of Passport Capital has echoed this via his timeless quote: "cash is most valuable when others don't have it." This refers to cash's utility as a hedge during a downturn as well as its ability to fund opportunistic purchases while others are forced to do otherwise.

For more investing wisdom, we've also posted up Seth Klarman's recommended reading list.


Embedded below are notes from Seth Klarman's Margin of Safety (email readers click the link to come view):



And if you want to read the original book, you can try to purchase one here.


For our past posts on the Baupost Group founder, head to:

- Collection of Baupost Group letters

- Interview with Seth Klarman

- Profile of Seth Klarman & Baupost Group

Lectures on Financial Economics by Antonio Mele (Swiss Finance Institute)

Continuing the series of educational articles on Market Folly, today we present Lectures on Financial Economics by Antonio Mele. Published in March 2012, it comes from the University of Lugano and the Swiss Finance Institute.

In the publication, Mele addresses:

Part I "Foundations": Fundamental tools of analysis such as classical portfolio selection, dynamic consumption- and production- based asset pricing.

Part II "Applied asset pricing theory": Excess price volatility, countercyclical stock market volatility, and value premium.

Part III "Asset pricing and reality": Option pricing and trading, interest rate modeling, credit risk, and derivatives.

Embedded below is Antonio Mele's Lectures on Financial Economics (email readers click the link to come read it):



For more of our educational posts, head to:

- Notes from Seth Klarman's Margin of Safety

- The 3 sources of Alpha

- Common sense investing: collection of Ben Graham's papers

What We're Reading ~ 4/18/12

Legendary bond manager says get into stocks [Reformed Broker]

Consumers as a lead indicator [FT Alphaville]

Why some value investors aren't even buying Best Buy [Contrarian Edge]

On the equity risk premium [Abnormal Returns]

Hedge funds & advertising: pay attention to JOBS Act [DDInvesting]

Mick McGuire's Marcato Capital closes to outsiders [AR+Alpha]

Understanding technical analysis in 500 words [Dragonfly Capital]

More on hedge funds and advertising [Reuters]

Study on short squeezes in individual stocks [SSRN]

Contrarian hedge funds find alpha [AllAboutAlpha]

On short selling [Bronte Capital]

Starting a hedge fund loses its appeal [Reuters]

Viking Global to rely more on junior managers [Reuters]

Hedge fund's billion dollar club loses out to small rivals [InvestmentEurope]

The curse of the Yale model [Forbes]

On an investment research trip to China [Also Sprach Analyst]

Dodd-Frank bill - views from the hedge fund industry [Eisner Amper]

Conditional Probabilities Between Hedge Fund Returns & Equity Returns

Burnham Banks has penned an interesting comparison of conditional probabilities between hedge fund returns and equity market returns on a monthly basis. For this study, he used the MSCI World Equity Index and the HFRI Hedge Fund Index.

He finds that:

- Since January 1997: when equities are down, a hedge fund's chances of losing money are 69% and when equities are up, a hedge fund's chances of losing money are 7%.

- Since January 2008: when equities are down, a hedge fund's chances of losing money are 81% and when equities are up, a hedge fund's chances of losing money are 4%.

It should obviously be noted that the second date range is skewed by the financial crisis as large equity declines saw large drawdowns at various hedge funds. At the same time, snap-back rallies in 2009 and 2010 also influenced things.

The numbers are intriguing, though, when you consider that in 2011, many hedge funds lagged their respective indices. While many attributed this to having inappropriate gross/net exposures, it could have also just merely come down to market timing as the Wall Street adage, 'sell in May and go away' held true and the market declined precipitously in the second half of the year.

One thing to consider is that the article says "forget about correlations." And on that issue, we'd highly recommend reading excerpts from Maverick Capital's investor letter. In it, founder Lee Ainslie addresses correlation, writing:

"Last year intra-stock correlations reached all-time highs, surpassing even the levels seen in 1929 and 2008. In other words, stocks moved in tandem with one another to a degree never before seen and were less responsive to idiosyncratic risks, such as fundamental factors, than ever before. Such an environment is clearly challenging for long/short investors who rely upon stock prices being responsive to fundamental differences among companies."

So when viewing the conditional probabilities above, you certainly have to keep in mind that the narrow, more recent date range includes two years (2008 and 2011) where correlations reached extremes and certainly affected hedge fund performance. You can read the article here.

Market Strategist Jeff Saut: Be Conservative, Not Conventional

Market strategist Jeff Saut is out with his weekly investment strategy entitled, 'Be Conservative, Not Conventional.' In it, he summons advice from Benjamin Graham, telling investors to focus on risk rather than returns.

He also quotes Ken Fisher from 1989, who offered prudent investing advice (emphasis ours):

"The two most definitive studies ever on long-term returns, the Ibbotson/Sinquefield and Fisher/Lorie studies, both point to average annual returns for stocks of 9% plus per year going back to the mid-1920s. So 15% to 20% per year is really 66% to 100% better than the market as a whole. That's tough but doable. Consistency is the key.

It's the math. A single year that is down 30% means you have to get 30% per year positive returns for the next four years to get back on track for a 15% annual average. Or, if you score 20% annually for four years, and then suffer a 30% decline, your five-year average return is only 7%."

With this quotation and the recent market decline, it's quite obvious that Saut is trying to get investors focus on the 'risk' aspect of the equation, rather than the oft-lusted 'reward' side.

Saut also mentions technical analysis and levels on the S&P 500 he is watching. While he saw minor support around 1360-65, his hunch was a break below 1375 brings into play the 1320-1340 level as next support (the market currently trades around 1370).

He believes that this, coupled with a break below the 50-day moving average, warrants a cautious approach. The strategist points to shares of Apple (AAPL) as a tell. It's often thought that market leaders such as AAPL are the last to fall in declines... and AAPL has done just that recently.

Embedded below is Jeff Saut's full market commentary:



You can download a .pdf copy here.

To read additional thoughts from Saut on the market decline, see his missive: waiting for a fatter pitch.

For more from this strategist, head to his thoughts on currency dilution causing money to flow into all assets.