Macro Tsimmis

intelligently hedged investment

Archive for December, 2006

Our tactics for the ISOP (speculative portfolio)

Posted by intelledgement on Sun, 31 Dec 06

The Intelledgement Speculative Opportunity Portfolio (ISOP) starts at $10,000, which is one-tenth the size of our investment model portfolio (Intelledgement Macro Strategy Invesment Portfolio or “IMSIP”). Although we are putting only one-tenth as much money into this one, we anticipate the components of the speculative portfolio will be significantly more risky and higher maintenance than those of the IMSIP; consequently, we anticipate a lot of turnover here.

Why do we plan to spend time on a portfolio only one-tenth the size of our main model portfolio…one we are warning folks not to invest any serious amount of money in? Two reasons: [a] it will be fun and [b] it will provide us with valuable intelligence.

The ISOP is not an investment portfolio; it is a speculative portfolio. What’s the difference? Essentially, the risk is greater, as are the potential rewards. Branch Rickey, the general manager of the Brooklyn Dodgers in their most successful years, famously stated that “Luck is the residue of design.” Clearly it is our intention in placing speculative bets here to position ourselves to benefit from—or take advantage of—good luck. With our investment portfolio, our intention is reduce risk and position ourselves to benefit from what the market is going to do anyway. In effect, with the investment portfolio we are emulating a conservative hitting approach in baseball, whereby the batter is just trying to “go with the pitch” and “put the bat on the ball,” content to settle for a sharply hit ball anywhere, which is likely to result in a single—modest success. With this portfolio, we are “swinging for the fences” and trying to hit a homerun. When we connect, at least one and maybe more runs will score for sure—dramatic success—but the odds of striking out—total failure—are much higher.

However, we believe that in order to make optimal investment (strategic) decisions, we need to be aware of what is happening on a tactical level in the trenches. What we learn while tracking some key speculative positions will increase the chances that our strategic decisions will be good ones. Even if we get badly burned on some of these speculative adventures, with the downside limited (because we are not investing much in any one idea), we expect the value of the information we learn will outweigh any loss.

And speaking of warning folks not to invest any serious amount of money here…it would not be prudent to invest any sum of money that you can’t afford to lose in any speculative portfolio component. Even the biggest and best run companies are vulnerable to Bhopal-scale disasters, automobile-scale technological advances that roil existing markets, and dollar-decline-scale macro trends. Most of our spec plays here are likely to be smaller companies who also have to worry about losing key personnel, Microsoft (or equivalent) entering their market, or two guys in a garage dreaming up a product that will knock them off…in addition to all the bigger-scale risks. This is why for investment—as opposed to speculation—we recommend ETFs, wherein diversification reduces risk.

And if, after all that, you do stubbornly pursue any of these ISOP recs, then you need to pay attention to what is going on there to optimize your ROI.

For our part, the same ROI accounting rules apply here as to the IMSIP: any transaction announced here when the market is open will be settled at the closing price. For announcements made when the market is closed, the next opening price will be used to settle the transaction. Exception: announcements made less than one hour prior to the close of the market are considered to have been made after the close. Initial positions will generally be limited to 10% of the ISOP and may include stocks, options, bonds, and other securities. We may also sell equities short if it seems like a good idea at the time.

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Intelledgement’s Investment Strategy

Posted by intelledgement on Sun, 31 Dec 06

We seek the best compounded annual growth rate we can get in excess of the S&P 500 and the Greenwich Alternative Investments Macro hedge fund index utilizing Macro strategy-informed investments in—primarily—exchange-traded funds.

Macro analysis is one of the classic strategies employed by hedge funds. Typically, macro hedge funds aim to profit from changes in global economies brought about by shifts in geo-political factors that impact interest rates, currency, stock, and bond markets. Macro hedge funds invest in all major markets—equities, bonds, currencies and commodities—though not always at the same time. Most aggressively utilize leverage and derivatives to accentuate the impact of market moves. According to the Greenwich Fund Indices (which are an industry standard), Macro-strategy hedge funds on average between 1988 and 2005 produced a compounded annual growth rate (CAGR) of +16%, which handily beats the CAGR of the market overall during the same time frame (S&P = +9%).

In times gone by, it was not very easy to employ a Macro strategy approach for a modest-sized portfolio. You couldn’t invest in a hedge fund directly (and still can’t) unless you are an accredited investor (annual income of $200,000+ and/or net worth of $1,000,000+). And to duplicate the strategy yourself, you would need a brokerage account with a margin agreement that enabled you to trade options, a commodities trading account, and a currency trading account. Capitalizing these with limited funds—not to mention withstanding the volatility inherent in leveraged- and derivatives-steeped strategies—would be problematic at best. Also, these are not fire-and-forget type investments; they really need to be actively monitored when the market is open…a little tough to do when you have a day job.

With the relatively recent advent of exchange-traded funds (“ETFs”), however, it is now possible to invest in commodities, currencies, industries, sectors, national stock markets, and, of course, indices with a modestly-sized Macro strategy-informed portfolio all in a single brokerage account. Many exchange-traded funds are similar to mutual funds in that their value is based on a compilation of different components (e.g., the S&P 500). The key difference is that ETFs, instead of being priced once a day after the market closes, are traded throughout the day just as regular stocks. If you want to buy shares in an ETF, you buy them as you would buy a stock—namely from someone else who sells them to you via a stock exchange (hence the name “exchange-traded fund”). But there are also ETFs that track only one component (e.g., gold or Swiss francs). And there are “short” EFTs (e.g. DOG, which increases in value when the DOW declines).

We believe that employing a Macro analysis strategy to selecting investments whilst eschewing aggressive use of leverage and the vagaries of individual stock ownership reduces risk without compromising overall return on investment. In order to demonstrate this strategy, we have set up a model portfolio launching here at the start of 2007. The portfolio is based on a virtual investment of $100,000 and will take into account a 1% annual management fee assessed on the principal, commissions, dividends, interest, and so forth. Investments will be in ETFs (primarily), with no individual stocks. The performance of the portfolio will be tracked on this blog via quarterly reports and also via the third-party portfolio tracking tools on the Marketocracy website (scaled up to a $1 million virtual money portfolio; this website also accounts for a 1% management fee, commissions, dividends, and interest on cash) and The Motley Fool website (“CAPS,” which explicitly measures performance against the S&P 500). All buy and sell decisions will be posted on this weblog before being “executed.” For transactions announced between 0830 and 1530 EST/EDT on days when the market is open, the closing price will be used to determine the cost/proceeds. For transactions announced after 1500EST/EDT on days when the market is open or anytime when the market is closed—except between 0830 and 0930 EST/EDT on days the market is open)—the opening price the next time the market is open will be used to determine the cost/proceeds. (We cannot precisely control the prices obtained for Marketocracy or CAPS transactions, but we will do our best to obtain similar prices.)

The Intelledgement Macro Strategy Investment Portfolio is not designed to be an optimal fit for every client’s needs. However, we do intend for it to serve both as our cardinal benchmark to measure performance and mechanism for reducing risk. Accordingly, each client should expect any portion of their assets allocated to equities to approximate the positions of the model portfolio unless we mutually agree otherwise.

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Running with the Wolves

Posted by intelledgement on Sun, 24 Dec 06

I write these words sitting in my father’s cabin in Big Bear Lake, California; we are visiting in hopes of getting in some real skiing. The skiing in North Carolina was never great and ever since Al Gore invented global warming, it has become yet still lesser than great. Conditions here are a bit cramped…Lee normally shares the place with three cats and two wolf dogs, and piling five additional humans into the mix is a bit of a challenge, what with the one bathroom and one dialup internet connection. But the company and food is good, and there’s plenty of snow on the mountain, and he lives in a national forest allowing the wolf dogs the freedom to roam for acres and acres…so what’s not to like?

I mean to write about the model Intelledgement Macro Strategy Investment Portfolio (IMSIP) that we plan to launch next week…but this is a funny sort of investment report, in that we haven’t actually taken any positions yet. I guess that’s OK, however, as [a] we pretty much know the securities we are going to be buying and [b] I really want to talk about not so much what we are buying but why we are buying it/them.

Six years into the third millennium finds capitalism ascendant, but democracy under unanticipated pressure. In the wake of the collapse of the USSR, it appeared that what we like to think of as “the American way of life” was sweeping to world-wide triumph. Huge swaths of Eastern Europe began holding genuine elections and even Russia followed suit. As the last days of the 2oth Century ticked away, the old Cold War alliance still proved able to deliver the goods in Bosnia and Kosovo, and although it failed in the Sudan and failed even to try in Rwanda, these were considered sideshow conflicts with no serious international implications.

To be sure, there were some clouds on the horizon. The long-term health of the US economy was the most salient of these, if only because the USA is the bastion of democratic capitalism—without us, the Allies probably lose WWI and certainly lose WWII. But after years of running up budget deficits on top of the looming demographic time bomb of structural social program deficits—not to mention declines in savings rates, increased abuse of credit by consumers, and ever-widening trade deficits—in the years running up to 2000, the government magically appeared to solve the budgetary problems and have a handle on the solution to the social programs demographic issue. And perhaps free trade would improve the current accounts situation.

Another fly in the ointment was the rise of China. Since the defeat of the Gang of Four in the 70s settled the debate over the utility of communism vs. capitalism, the Chinese economy has been inexorably on the rise. But in the wake of the Tiananmen Square disaster, it became evident that the political elite harbored no tolerance for dissent either tactically or strategically. As the Century turned, it was an open question whether the economic need for creativity and innovation combined with the advent of 21st Century social communication tools would succeed in overwhelming the elite’s mania for tight control and move China towards the democratic capitalist norm.

The third concern was the festering strain of Islamic “fundamentalism” which rejected modernity and considered Western-style democracy as fundamentally subversive and antithetical to the natural order of things. But six years ago, this still seemed more an annoyance than a top-tier problem.

Then came 9/11. And six years later, all of these concerns loom much, much larger.

In the wake of ill-advised adventures in Afghanistan and Iraq, the US government’s finances lie in tattered ruins, with huge budget deficits financed through the kindness of foreign strangers, and six precious years past with no solution to the entitlements demographic time bomb in sight. The private sector has continued a stately expansion (following an initial convulsion after 9/11), but the savings rate had dipped into negative territory, credit debt is at an all-time high—with interest rates on the rise—and a bubbly real estate market has inveigled thousands of homeowners into houses that now appear overvalued, paying mortgages whose adjustable rates are soon due to rise from enticingly low teaser rates to the point where folks could easily be paying out more than the property is worth. Don’t even mention the trade deficit. On top of that, the competition for jobs from offshore has grown to the point where real wage growth is threatened, and inequality is growing, while political support for free trade wanes.

On the other hand, six years later, China is much more powerful, but no less authoritarian. 21st Century social networking tools have proven less of a viral mechanism for spreading diversity of opinion and more of an Orwellian tool for social control. The precept that “knowledge is power” cuts two ways: by disseminating information, it can empower heretofore ignorant folks to act more effectively in their own self interest, but by enabling central power brokers to collect information and monitor the activities of their citizens, it can also facilitate the suppression of dissidence. Furthermore, in the past six years, Russia has clearly backed away from the democratic capitalist norm and moved closer to the Chinese authoritarian capitalist model. It is by no means clear that the democratic flavor of capitalism will prevail in the long term.

And as for the Islamicists, the last six years have been a litany of triumph, with one misstep by the West after another: following the initial 9/11 attack, the USA blundering first into an indecisive sideshow in Afghanistan, then into a disastrous entanglement in Iraq—which eliminated the most ruthless and committed Arab modernist, demonstrate daily the point that the USA is imperialistic and seeks domination, and provide priceless propaganda triumphs (Abu Ghraib, Guantanomo Bay, a plentitude of instances of “mistreatment” of Afghanis and Iraqis by US military personnel)—the brain dead reaction of the Spanish government to the terrorist attacks there which lead directly to their defeat at the polls, the arrogant idiocy of the Israelis at once handing the Hamas extremists a huge victory and eviscerating a great potential ally in the pro-Western Lebanese government…the beat goes on.

So now we are in a pickle—the twilight is darkening, we are gathered around a flickering campfire, but the supply of wood is nearly gone and the wolves are gathering…they seem to be baying to each other from every direction. We have a bow but only a couple of arrows, so fighting is not a good option. Of course if wishes were horses, we could just ride away from danger and then focus on fixing the conditions that lead to the danger arising…but we have no horses, so that’s not an option. Right now, our priority has to be preserving life and liberty in order to maintain the opportunity to fight another day, under more favorable circumstances.

And that, in short, is the strategy of the IMSIP for 2007 and the foreseeable future: if you can’t beat ’em, join ’em! We will be hunting with the pack for opportunities to preserve and where possible to enhance wealth through a coming time of troubles. Our macro analysis tells us the USA economy is likely to decline, so we will eschew most USA-based investments and focus on where the growth is. Our analysis indicates that commodities are in demand, so we will look to preserve and enhance our wealth accordingly. Our analysis warns that a significant economic disruption is likely in conjunction with the demise of the dollar, so we will be prepared to shift into a defensive mode shorting the indices if appropriate. And if the more dire global warming predictions come to pass—or if enough folks come to believe they will—there will be serious economic consequences and we will need to adjust accordingly.

In the next week, we will be posting recommendations for the particular tactical positions we plan to take as of the start of 2007. We will publish any changes we make to the portfolio as they happen—although we do not anticipating making any trades for a year unless militated by our macro analysis—and we plan to publish portfolio updates quarterly.

Well, the skiers are back from Big Bear and the sun is beginning to sink in the west. Time to log off the computer and head out for our daily run with the wolves.

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