Credit Stupid?

Did Credit Suisse have a James Bond complex?

Consider this business model. In order examine your finances, you have to: 1) leave the country; 2) call your banker in Switzerland; 3) fly to Switzerland; 4) meet your banker in a nondescript white room; 5) view your statements—in person only; 6) verbally instruct your banker what to do; 7) receive any money from the account in cash; 8) tell your banker to destroy all written records; 9) return home.

I’m not making this up. This is customer service? Apparently, a lot of people managed their money just this way, calling theirs bankers from Mexico and flying to Zurich for a meeting. Credit Suisse even opened up a branch at the Zurich airport to make it more convenient for clients—they could have their meetings during flight layovers on their way somewhere else.

Apart from satisfying a desire to play “[youtube],” what possible business purpose did all these cloak-and-dagger maneuvers accomplish? Clearly, they were designed to avoid having records of the client’s wealth and income available to anyone. This wasn’t confidential financial advice and tax-planning. These were accounts designed to evade any reporting.

You can avoid taxes with legal structures that carry opinion letters from counsel and have a legitimate economic function—like tax-exempt munis, or limited partnerships that return capital. Or you can sneak around, hide the income, and just not report it. Clearly, Credit Suisse’s approach was the latter.

It can be fun to play James Bond. Until you get caught.

Douglas R. Tengdin, CFA

Chief Investment Officer


What do you think about Bitcoin?

The crypto-currency has been in the news a lot, lately. What started as a way for math-geeks to keep score with one another has developed into a significant item for payments and money transfer. Bitcoins are pieces of computer code that can be stored offline and are—to this point—impossible to replicate. They can be “mined” by solving very difficult math problems, and once created can’t be destroyed.

There is no central repository of who owns which bitcoin, although each bitcoin comes with a serial record of who mined it and who has owned it over time. Users can establish anonymous identities to preserve their privacy. The algorithm at the heart of each bitcoin’s creation and transfer is elegant, and thus far, has not been replicated. To date, about $6 billion in bitcoins have been mined.

Two days ago the largest bitcoin exchange, Tokyo-based Mt. Gox, shut itself down amid rumors of massive theft. Mt. Gox handled about a third of all bitcoin/currency exchanges. It’s the equivalent of a bank closing its doors—and folks with funds there can’t get at their bitcoins—reported to be worth almost $400 million. But because it’s not officially a currency, there’s no clear path to restoring its operations.

Bitcoin has popularized the idea of a virtual currency; it has many cash-like properties. Because it preserves the anonymity of its users, it is the exchange-medium of choice among drug-dealers, identity-thieves, and other criminals. It’s also popular among libertarians looking for a currency that doesn’t involve a central bank. But its distributed nature is also its risk: as the Mt. Gox episode shows, bitcoin users have limited options if their funds go missing.

Because of the potential for abuse, authorities are watching bitcoin carefully. In Russia and China, it’s illegal to exchange bitcoin for anything. If the cryto-currency becomes so popular that it materially threatens tax revenues, I’d expect the Fed to co-opt it—maybe by issuing “Fed-coin.”

Douglas R. Tengdin, CFA

Chief Investment Officer

The Conversation (Part 3)

What good is privacy?

The Fed lost a lot of privacy when the microphones were turned on and their meetings were recorded. When Congress found out in 1993, they wanted the transcripts released two months after the meeting. Transcripts and videotapes. The Fed threatened to destroy its tapes; Congress proposed a bill requiring disclosure.

The Fed broke the impasse by stating clearly—right after their meeting—what their monetary policy was. Before 1994 the Fed engaged in market actions—repos, T-Bill purchases, Note purchases—and Fed-watchers divined what was happening. Greenspan called it, “Creative obfuscation.” Starting that February, they proclaimed their policy-decisions to the world.

The Fed then announced, on its own, that it would release their transcripts five years later. (Five years can seem like a long time, but 2008 feels like yesterday to me. I don’t think I’ll ever forget those days.) By agreeing to issue an immediate press-release, but preserving and releasing later their recorded deliberations, the Fed has come to a kind of understanding with Congress regarding its communications.

Openness is good. It lets people see how the sausage of monetary policy is made. But there is a place for confidentiality, too. As with diplomacy or law enforcement or personal medicine, people need to be free to discuss issues without the fear that they end up in tomorrow’s papers.

But eventually, the truth comes out. What’s decided behind closed doors will be discovered, one way or another. Five years seems a good compromise.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Conversation (Part 2)

How would you like to be recorded?

In 1993 the Fed found out that their meetings were being taped. In fact, they had been recorded since March of 1936. But only the Chairman knew about the taping, which began in the ‘70s. Presumably the Governors who saw little microphones embedded in the conference room table thought they were there to amplify the speakers’ voices in the big room. Little did they think they were speaking for posterity.

When it became known that there were word-for-word transcripts of Fed meetings, Congress pressured the Fed to release them. The Fed is sensitive to criticism—they know that they’re unelected and yet incredibly powerful. Fed policy has an immense impact on the economy. Eventually, the Fed agreed to release these transcripts to the public with a five-year lag.

There are good public-policy reasons for transparency—avoiding the appearance of conflicts, improving the policy-making process, and so on. But the Fed also fears encroachment on its independence. There’s always short-term pressure for lower rates and looser policy, in spite of the poisonous long-term effects of inflation. And the mere presence of microphones changes the way people behave.

In 1974 Gene Hackman starred in a psycho-thriller entitled, “The Conversation.” In this film a security expert produces a tape where the words are crystal clear, but the meaning is ambiguous. When he misinterprets the tape, his life is tragically changed. Let’s hope that we don’t miss the meaning of the Fed’s conversation.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Conversation (Part 1)

What did we learn from the Fed’s transcript?

On Friday the Federal reserve released its transcripts of Open Market Committee meetings that took place in 2008. These are word-for-word records of the debates, announcements, research findings, jokes, and worries that each of the Fed Presidents and Governors had during the greatest Financial Crisis in over seventy years.

The eight meetings and five conference calls generated almost 1500 pages of recorded conversations among policymakers that will be examined for years to determine whether the Fed acted effectively and expeditiously in addressing the crisis. Some of that will be Monday-morning quarterbacking, but some will be legitimate analysis to see what works and what doesn’t work in monetary and regulatory policy.

Already some journalists have looked at the use of humor during the Fed’s meetings and note that as the crisis deepened, the moments of laughter during the meetings became more infrequent—and the jokes got darker. Just after the Fed agreed to extend JP Morgan the credit it needed to purchase Bear Stearns and assume its debt, Chairman Bernanke mocked the alphabet-soup of Fed programs by repeating the vowels: “AEIOU.” New York Fed President Geithner lightened the mood by responding, “Don’t say IOU.”

One thing is clear from these transcripts: the new Chair, Janet Yellen, was always extremely well-prepared and articulate. She was frequently quoted by the other Governors, and by all accounts she had a fiercely loyal professional staff. Ben Bernanke was a student of Great Depression who helped avoid a repeat of that crisis in the early 21st century. Janet Yellen will be an excellent successor. We should be encouraged that the Central Bank’s leadership appears so competent.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Competitive Edge (Part 5)

So how do you get a competitive edge?

The answer is simple: you already have one. Everyone has something they’re good at. Whether it’s understanding how a store’s layout might be confusing or knowing what kind of computer games kids are playing, everyone has some kind of expertise.

As we go about our lives, we all have favorite activities, favorite stores, favorite brands we use. We become experts on motorcycles, camping gear, or farm equipment. Suppose you work in a hospital; you likely have a better understanding of which medical devices are popular right now than most financial professions, because you see these products in action every day.

Insight gained everyday interactions is often more valuable than Wall Street’s research. People know when something is increasingly popular, or when a company offers good value. When Apple sold the iPod cheaper than other MP3 player many investment pros were skeptical—but consumers lapped it up. Offering an inexpensive, convenient way to listen to 99-cent songs was a winning formula.

When people focus on what they already understand, they are more likely to be able to hold on through Mr. Market’s ups and downs. In the short run stock prices seem disconnected from a company’s success. But in the long run there is a 100 percent correlation.

Investing is a competitive activity where everyone wants to be above average. But if you use the expertise you already have, you’ll be more likely to achieve your financial goals—and have some fun along the way!

Douglas R. Tengdin, CFA

Chief Investment Officer

The Competitive Edge (Part 4)

Everyone’s looking for an edge. How can you be sure that you have one?

There are three paths to performance: working harder, working smarter, and working calmer. Working harder is simple: do more research and apply what you know to what you own. It’s simple but not easy. It requires more reading, phone calls, meetings, and everything. It’s physically exhausting.

Working smarter requires a deeper understanding of the way the world works. Competing this way requires you to consider how and why people behave as they do. These investors are more like financial philosopher;, philosophical concepts dominate their thinking. They can often see a trend before it emerges. It’s intellectually hard.

Working calmer means you keep your head when everyone around you is losing theirs. Often you have to get away from the financial centers like New York—or just not answer the phone. And you often do the opposite of everyone else, selling when markets are exuberant and buying when they seem depressed. It’s emotionally difficult.

Hard work, smart insight, and a wise temperament aren’t easy. But they’re the only way I know to maintain a competitive edge.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Competitive Edge (Part 3)

It’s not so easy.

Picking growth companies that can benefit from social or technological trends isn’t like going to the grocery store and buying a gallon of milk.

A case in point is Amazon. That company would seem to epitomize a growth stock. They’ve expanded from selling books online to selling pretty much everything; they’ve designed and delivered a powerful e-reader that’s re-making the publishing industry; and their web-site hosts hundreds of other companies that want to pursue e-commerce. Their sales have increased from $7 billion to $75 billion per year over the last 7 years.

And their price has grown, too, increasing an average of 35% per year—much faster than the rest of the market. But there’s the problem. High performance leads to high prices; high prices mean high risk. So when they announced last month that they didn’t meet analysts’ expectations, the stock took a serious tumble, falling over 20% in a few days. Yikes!

It’s easy to be wrong in this business. Folks who avoided Amazon because it was an expensive stock five years ago missed out on the way up—and if they capitulated and bought in recently, they’re riding the roller coaster down. That’s why diversification is so important. There are a lot of e-commerce companies—Amazon, eBay, Netflix, Apple—and each offers a bumpy ride. But together they’re less volatile than any one of them.

We don’t know the future. But through hard work and insight we can see some major trends. The problem is, millions of other investors are trying to do the same thing, and prices get expensive. By diversifying, we may not see our portfolios quadruple in five years, but we can smooth out some bumps along the way.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Competitive Edge (Part 2)

How do you pick winning stocks?

That’s the question that many ask. Security selection is a key way to add value to a portfolio, one of the three approaches mentioned yesterday. Critical to finding winning securities is having a way to identify them.

One common approach is the value method. This looks at a company’s financial statements and compares them with its market value. If the company is cheap enough, it’s a buy. An example is the A&P chain store. After going public in 1929, it declined during the depression to a value below its working capital. Canny investors bought it and saw the price triple in a year.

Value investors tend to look at a company’s balance sheet to find opportunities. By contrast, growth investors look how a company is run—whether it is positioned to capitalize on demographic trends or new technology to expand into the future. Global growth investing involves understanding how countries develop, and to capitalize on these changes.

A growth investor might have seen database design as a critical future industry in 1990, and have invested in several competing database startups—Sybase, Progress, and Oracle. Over the next 20 years, these three firms returned an average of 15% per year, while the broad market advanced at half that rate. But it was a bumpy road!

Growth and value investing are different ways to deliver the same result: superior returns. Both require insight, intelligence, and patience. The key is knowing how an approach can fit into your style.

Douglas R. Tengdin, CFA

Chief Investment Officer

A Competitive Edge (Part 1)

Investment is like sports. Performance can be measured, and compared with others. It’s important. One percentage point of excess return over 20 years can add 25% or more to a portfolio.

The market’s return is just an average of every investor, weighted by size. For someone to beat the market, someone else has to get less than the market. It’s like a running race: each competitor has his or her individual time, but each contributes to the course average. How you do relative to the course average is your relative performance.

In investing, there are really only three sources of excess relative performance: market timing, security selection, and execution efficiency. Market timing is easy to understand but hard to do: be in stocks when the market is going up, and in cash when it is falling. The problem comes in picking which days. It’s possible, but it requires a lot of focus.

Execution efficiency has to do with trading. It’s what trading firms with microsecond algorithmic computers are trying to do. It’s interesting, but most people don’t have access to the necessary data.

The most common source of excess return is security selection: finding the right stocks or bonds or funds, and holding on. There are a lot of ways to do this: value investing, growth investing, global investing, and others.

It makes sense to pursue every way to get an edge. Because when the returns are in, that market may weigh the dollars, but what determines your results will be your sense.