Friday, September 30, 2011

Pensions Raising Cash, Trimming GPs in PE?

Still 100% cash in my portfolio and glad I'm not trading in the last days of this quarter. Been trading terribly lately and it's pissing me off because I'm in no position to lose any money. I'll tell you what else is pissing me off, this rigged market which continues to be hijacked by high-frequency trading assholes and naked short-selling criminals while the SEC and other regulators sit on their hands and refuse to take action.

Instead of covering up Wall Street crimes, providing them with more ammunition to continue the great retirement heist, the SEC should reinstate the uptick rule, but regulators in the US and elsewhere are proving to be the most corrupt, inept, incompetent fools of all the players in the financial world. I'd fire all of them but since they're public sector employees, they're protected and their incompetence goes unnoticed while they aid and abate Wall Street wolves. Then again, the 'United States of Wall Street' is headed down the wrong path as each successive government bends over and panders to the banksters running their country. I hope the new movement of occupying Wall Street takes off in a spectacular fashion so someone can knock some sense into these Wall Street thieves and their government cronies in the White House and Congress but I'm not holding my breath. Nothing happened after 2008 and nothing will happen now.

Pragmatic Capitalism posted an interview with Vanguard’s Jack Bogle who sat down with Fox Business on Thursday to discuss the US economy and the markets in general. The level headed market makes some interesting comments. He says the current market is “rigged” by speculators who are just driving prices all over the place on any given day. As for the general economy, Bogle says we have tough sledding ahead of us:

On if the market is rigged right now:

“The game of prices is rigged. The game of values cannot be rigged. In the long run, the returns on stocks are created by how corporate America does.”

On if anything is still too expensive in the market right now:

“I don’t even try to guess that. You’re pitting one investor against another in the market. It’s a loser’s game. I’d say three years before we can get the American economy doing what it is supposed to do again. It will take time and patience. The market is a great arbitrage mechanism.”

Bogle is 100% right. This market is beyond rigged, it's run by a bunch of crooks programming algorithms on multi-million dollar computers that send share prices wherever they want. I can easily prove this to you as every single day I sit down and trade, I see the bullshit going on in markets, typically at the open or close of day but lots of intra-day nonsense too.

I've learned the hard way that while I can't beat computers trading on a short time frame, I can beat them by extending my time horizon because computers or no computers, market trends are always occurring. I've also learned that in this wolf market, extremely oversold can become INSANELY OVERSOLD and it's not worth trying to pick a bottom (seen shares of solid companies get slaughtered in a few weeks for no good reason). I prefer to enter a trade a little later after my indicators confirm the price is reverting robustly than try to be a hero and get my head handed to me. Also if the price is going against me, I get the fuck out (unless you actually traded on your own, lost money and learned the value of losing money, you'll never make money trading).

I've also learned the value of not trading when your mind is preoccupied or when your just not sure of where this schizoid market is headed. Cash gives you powder to trade and make money. No cash, no powder, and you're pretty much screwed to take advantage of any opportunities that present themselves. There were several Bloomberg interviews that caught my attention this week. One of them was with Lawrence Schloss, chief investment officer for the City of New York, who discussed the outlook and asset allocation for the city's pension funds.

Schloss said that six months ago, they sold equities and high yield bonds to raise their cash levels because they were worried." He added: "There is too much uncertainty now to have their liquidity or cash in the stock market." Incredibly, they raised their cash levels to 8% when they're usually at 0%! He said they're not "day traders' but he prefers to slowly leg their way into stocks as they try to "catch the bottom." He said that US public funds don' have much exposure to European sovereign debt (except via their hedge fund investments) and that they don't plan on increasing the cash level more but I found this strategy to be an intelligent way to manage liquidity risk, one that more pension funds should think of when markets go haywire.

[Note: One senior corporate pension fund manager I spoke with yesterday told me they are now going long high-yield bonds as spreads have blown out too much. He told me they actually made money in Q3 on their leveraged bond portfolio and he warned me of another "perfect storm" for pensions as yields drop and equities sink.]

On NYC pension funds' private equity exposure, Schloss said they are slowly trimming their exposure to GPs because they have "110 GPS managing 170 funds." He rightly notes that this makes it a big "private equity index" and in private equity, only "top quartile managers" are worth investing in. I would argue that even top quartile managers are struggling in this environment which is why many Canadian public funds have decided to go the direct route in their private equity investments, cutting fees and having more control over their investments (many of these are co-investments with top funds).

The other Bloomberg interview that caught my attention was with Henry Kravis, co-founder of KKR & Co., who talked about the cost of capital for leveraged buyouts, the private equity industry and KKR's business strategy. Listen carefully to what he says about private equity today and the value of being flexible and the value of KKR's "operational expertise." As I've written, the old private equity model of financial engineering and leveraging up a company to wazoo is dead. The new private equity kingpins will go back to the basics and focus on operational efficiencies.

I also noted KKR is still investing in China (guess they don't believe in China's "hard landing" scenario) and that the cost of capital on leveraged buyouts today has gone up significantly for many transactions and "you can't put on as much leverage as before." The debt crisis has impacted the cost of capital and leverage these funds which in turn will impact returns for their investors. I like what he said about the easy part is "buying a company" but the hard part is to add value on operations. They use a 108-point plan and believe in measuring operational success by putting the proper metrics in place to measure operational efficiency. "Going forward in private equity, those opportunities will always be there....in fact, we've always thrived when there were dislocations" but he added that you have to focus on the macro environment and be flexible.

Kravis also warned that there is higher risk in investing in private equity today but if you have a long enough time frame, you can still make a lot of money. He rightly notes that corporations are too focused on quarterly performance which hampers them and that many CEOs are exploring "taking a company private" to develop their long-term strategic plan which plays right into KKR's hand. He thinks valuations will come back to attractive levels but right now things are expensive. They're still trying to deliver 500-600 bps over public markets to their LPs but I think that's going to be next to impossible in this environment.

I also like what Kravis said about the culture at KKR and how every employee is an "owner" because it's a "team sport." Pension funds and investment firms can learn a lot from this approach but most of them have the wrong culture (and wrong people) in their organization where silos are put up and few people talk across asset classes or business units. Kravis agrees that pension funds should shrink their relationships with private equity GPs and have a more concentrated portfolio of managers. This is exactly what Réal Desrochers did at CalSTRS and what he's doing now as the head of CalPERS's private equity.

Finally, Kravis discusses the great uncertainty which is caused by "regulations and higher taxes." He thinks that America has a "spending problem, not a revenue problem." I would argue that America has both a spending AND revenue problem, and ultra wealthy folks like Henry Kravis should listen to the oracle of Omaha, stop complaining and pay their fair share of taxes (see Bloomberg interview below).

I recommend you watch all the interviews below. Also, want to remind you to please donate generously to my blog as I put a lot of time, effort and thought into my blog posts to inform you of insightful topics on pensions and financial markets. If institutions can afford to disburse millions on broker fees, hedge fund and private equity fees, independent research, then they can afford to pay me a fraction of that for my effort. And trust me, nobody has the guts, brains, time, experience or the contacts to keep blogging on pensions and markets the way I do.

Please contribute to this blog by clicking on the PayPal "donate" button at the top of my blog under the big pig (even though it says donate, I am not a charity, just PayPal's wording which I can't change). You can also contact me directly at (LKolivakis@gmail.com) to help me monetize this blog or discuss contract work. Thank you.



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