Today's Interesting Articles - May 29, '07

Do rising markets make you a trading genius? By Greg Kratz Deseret Morning News So far this year, the Dow Jones industrial average is up more than 8 percent, the S&P 500 is up more than 6.5 percent and the Nasdaq is up more than 5.5 percent. And if you look back to last year, those percentages get even better. In other words, this investing thing is easy, right? Let's trade! Well, let's not get carried away. That's the advice of two professors at Brigham Young University's Marriott School of Management, who published an article in the Review of Financial Studies last year. Steven Thorley, the H. Taylor Peery professor of finance, and Keith Vorkink, the Richard E. Cook associate professor of finance, completed the study with Meir Statman, the Glenn Klimek professor of finance at the Leavey School of Business at Santa Clara University. And even though Steven says they did much of the research and legwork six or seven years ago, its findings are relevant today. "Our motivation was, originally, the somewhat casual observation that an old saying on Wall Street is correct: Don't confuse brains with a bull market," Steven says. He says their research found that trading volume on Wall Street seemed higher than usual when the market was rising, but once the market went down, trading volume dried up. After validating that observation with research databases, they turned to the question of why. "We came to the conclusion that it's related to a very well-documented and now very important behavioral phenomenon called overconfidence. ... People tend to be overconfident in their own skills," Steven says. But overconfidence was not the only possible explanation for the jump in trading. Keith says they also checked the potential impact of the "disposition effect." "The disposition effect states that we get satisfaction or, as economists like to call it, utility, from actually realizing a gain on a trade," Keith says. "For example, if I buy IBM at $50 a share, and it goes up to $75 a share, I get more utility from that outcome when I sell IBM at $75 and realize a gain, as opposed to keeping IBM in my portfolio. "So the alternative explanation for trading after the market goes up is that we all want the satisfaction of realizing our trading gains, and hence we trade." When the researchers put the two possibilities to the test, however, overconfidence was clearly more influential. "When the market goes up, we attribute the gains in our portfolio to our skill, and hence that makes us more likely to do subsequent trades," Keith says. A rising market leaves the average investor feeling like a genius, and people start talking about their portfolios around the proverbial watercooler. But those people tend to ignore the overall strength of the market.

"People shouldn't count their success by a gain in their portfolios," Steven says. "It should be how much better or worse their portfolio did than standard benchmarks, like the (Standard & Poor's 500) or the (Dow Jones industrial average). ... Having a gain of 12 percent in your portfolio really isn't very good if the general market went up 15 percent." Ignore that fact, he says, and overconfidence will lead to increased trading, which in turn leads to more transaction costs and brokerage commissions, not to mention possible tax issues. "Probably the most profound (detriment) from our perspective is just that people spend a lot of time and energy ... to do this trading, when in fact it doesn't do them any good," Steven says. Keith says investors should remember how competitive markets are. Many would be wise to pursue more passive investing in something like an index fund or exchange traded fund that mirrors the market's natural rise. "It's difficult to pick which stocks are going to do well, but it's pretty easy to minimize the fees and costs of trading," Keith says. So if the stock market's recent rise has pushed your exuberance near the level of irrationality, sit back, take a deep breath and ponder the results of this study. Maybe you are a stock-picking genius. Or maybe your desire to trade stems more from a bull market and less from brains. If you have a financial question, send it to [email protected] or to the Deseret Morning News, P.O. Box 1257, Salt Lake City, UT 84110. E-mail: [email protected]

The Private Equity Put By Emil Lee May 22, 2007 You've heard of the Greenspan Put, right? The theory was that when Alan Greenspan was the chairman of the Federal Reserve, if anything bad happened to the economy (and hence the stock market), Greenspan would bail investors out by dropping interest rates, the same way a put option hedges against a falling portfolio. As I watch today's stock market make an Icarus-like climb upward, I wonder if the Greenspan Put has been replaced with the Blackstone Put. What I mean by that is, virtually every day, another huge firm gets bought out by a private equity firm. Sallie Mae (NYSE: SLM), Clear Channel (NYSE: CCU), Harrah's (NYSE: HET), and First Data (NYSE: FDC) are just some of the companies being acquired by private equity firms for billions of dollars. According to a Barron's article by Michael Santoli, there has been a $5 billion or larger acquisition on 27% of the trading days this year, and the S&P returns on those days were double the returns of the rest of the non-buyout days.

As a result, it seems as if private equity activity has not only created a floor for stock prices, but also helped drive it to new heights. Musical chairs There's only one problem with this sequence of events: The private equity party could turn on a dime. PE firms are making fistfuls and fistfuls of cash because they can raise enormous amounts of money and borrow at ultra-low interest rates and extremely lax terms. As a result, they can bag bigger and bigger elephants, and because the debt market is so accommodating, it almost ensures those private equity firms will make money. You see, according to my understanding, private equity firms make the bulk of their money arbitraging the difference between a company's return on capital and its after-tax cost of debt. It's kind of like buying a house -- if you can buy a house, rent it out, and pay off the mortgage and other costs with the rental income, you are pretty much arbitraging the cost of debt (the mortgage rate) versus the return on capital employed. Private equity companies do the same thing, except instead of buying houses with a ton of debt, they buy entire companies. Their returns are better because they can add value through hiring better management, and also because there are only a handful of firms with the clout, financial wherewithal, and expertise -- as well as the, shall we say, cojones -- to make these billion-dollar bets. On the other hand, pretty much anyone can get a mortgage and bid on a house, which drives returns lower. However, trees don't grow like Jack's beanstalk, and there are a lot of events that could cause the Private Equity Put to expire out of the money: Interest rates go up Interest rates are pretty low by historical standards. This benefits PE firms in myriad ways. First and foremost, it lowers their cost of debt, which means their hurdle rates for target acquisitions are lower. In a nutshell, if someone gave you a billion dollars and only asked for a 1% interest rate payment, you could buy almost anything and make money. If they asked for a 10% rate, then you'd be much more limited in what you could do with the money and still make a profit after paying 10% on that debt. What could cause interest rates to go up? Bondholders hate inflation because it causes their future coupon payments to be worth less. So if inflation increases, interest rates usually go up with it. Interest rates are also low in the U.S. because the rest of the world, primarily Asia and the Middle East, has had a voracious appetite for U.S. government debt thanks to those regions' booming economies -- if this changes, then the cost of debt will go up. Credit risk premiums increase What is the price of risk? You pay auto insurance to eliminate the financial risk of getting into a car accident. When a PE firm buys a company, it has to pay a risk premium because the company becomes much more financially unstable with the debt piled on.

However, PE firms lately haven't had to pay much in credit risk premiums because there are a lot of investors, banks, and hedge funds willing to make loans to PE firms (also known as leveraged loans). However, this could change on a dime if any of those loans go under. It's very likely that when the first high-profile PE-backed company goes under, credit risk premiums will widen considerably as investors get skittish. PE returns sour PE returns have soared, so investors climb all over themselves to give them more money. As more and more PE firms raise multibillion-dollar funds, the competition becomes fiercer to put the money to work, which drives up acquisition prices and drives down returns. If the returns fall too low, then many institutional investors will probably stop giving PE firms so much money. How to play it I'm hardly alone in thinking that many different things could cause the "PE Put" to go away, which could bode poorly for the stock market. As a result, it's hard for me to be enthusiastic as I watch the stock market head higher on a one-way street. However, if I'm patient, I think I can buy stocks at a cheaper price if the "private equity put" expires.

AllBusiness

What Is HR Outsourcing? Tuesday May 22, 8:00 am ET By AllBusiness.com Whatever your company's human resources requirements, there's an HR outsourcing firm out there to meet those needs. Some HR outsourcing firms are generalists, offering a wide variety of services, while others are specialists, focusing on specific areas such as payroll or recruiting. Depending on the size of your business and how much control you want to maintain over HR functions, you can either outsource all your HR tasks or contract for services a la carte. The basic services offered by HR outsourcing firms may include: * * * * * *

Overseeing organizational structure and staffing requirements Recruiting, training, and development Tracking department objectives, goals, and strategies Employee and manager training Benefits administration Employee orientation programs

Businesses that outsource HR are typically small-to-midsize firms with between 25 and 1,500 employees. These businesses view HR outsourcing as

a strategic tool that relieves them of HR responsibilities and enables them to focus on what they do best. In addition to allowing you to concentrate on your core business activities, outsourcing provides some key benefits, including: * Providing you with skilled professionals who are focused specifically on HR * Helping you reduce and manage operating costs * Improving employee relations If you need to hand off the entire HR function, consider a professional employer organization (PEO). A PEO becomes the employer of record, handling employee relations, payroll, benefits, workers' compensation, and all the other areas that fall under the HR umbrella, while you manage the employee's everyday business responsibilities. For a step-by-step guide to using and hiring a PEO, check out our Buyer's Guide on Outsource Your HR Using a PEO. If you don't need the comprehensive services of a PEO, you can contract specific projects through an HR outsourcing firm to help you: * * * * * *

Implement a human resource information system (HRIS) Create or update employee handbooks and policy manuals Develop and implement a compensation program Create or review a performance appraisal system Write and update affirmative action plans Provide sexual harassment training

Referrals, the Yellow Pages, and the Web are the best resources for finding an HR outsourcing provider. You have the option of working with an international, national, or regional provider. Any one of those may be able to meet your HR needs. Whether you're looking to outsource the entire HR function, a portion of it, or a specific project, it's good to know you've got options -- lots of them. Get more tips on hiring Consultants and Contracts on AllBusiness.com. AllBusiness.com provides resources to help small and growing businesses start, manage, finance and expand their business. Copyright © 1999 - 2007 AllBusiness.com, Inc. All Rights Reserved.

SeekingAlpha

What Happens to Those Returns When They Move from Paper to Reality? Wednesday May 23, 2:42 pm ET

James Picerno submits: Investment performance is often less than it appears. The top-line number may impress, but after adjusting for real-world frictions, the net result may disappoint. Everyone knows this and, for the most part, everyone ignores it. Maintaining a sunny disposition is essential when it comes to deploying capital, and who really wants to let reality muck up the fun? Meanwhile, even for those who demand nothing less than the unadulterated truth, it's unclear how to adjust top-line returns to calculate something closer to reality. Although it's easy for everyone to generalize, the final numbers may not be applicable to anyone. This is also how it goes when you move from paper to reality in investing. That said, in those rare instances when someone takes the time to estimate the damage, the reality burst can be shocking, even if it's not precisely accurate. One example was dispensed on Tuesday, deep within the walls of New York's celebrated 21 Club, where Garrett Thornburg, CEO of Thornburg Investment Management, spoke to a room of journalists (including yours truly) on the hard facts of net results. Consider the S&P 500 (CDNX: SPX.V - News), for instance. According to Thornburg, the 11.7% annualized total return for the index over past 20 years through 2006's close fades considerably after deducting for a variety of monetary abrasions that cut into investors' take. Indeed, the annualized 11.7% for the S&P 500 falls to 6.5% after investment management fees, dividend and capital gains taxes and inflation, according to Thornburg. The dynamic is at work in other asset classes too. Again using Thornburg's numbers, we're told that annualized total returns over 20 years are smaller than they appear. In particular, # small cap stocks (as per the Russell 2000) fade to 5.9% from 10.9% # foreign stocks (MSCI EAFE) drop to 3.5% from 8.4% # long term government bonds (20 year Treasuries) slip to 2.1% from 8.3% # commodities end up with a negative 0.9% from a nominal 3.1%. Perhaps the most astonishing evolution is the one assigned to single family homes. The nominal 4.8% return posted over the 20 years through the end of last was sliced to a measly real return of 1.2% after taxes, fees and inflation, according to Thornburg. Among the conclusions that the analysis inspires is that: "Taxable fixed-income securities only make sense for the tax-exempt of taxdeferred investor....", according to the handout that accompanied yesterday's chat. Meanwhile, "...a 3% real return is a fair objective. More volatile stocks should aim for more than 3%. Less volatile bonds might aim for less than 3% (although, high-grade, tax-free bonds have actually exceeded that over the past 20 years)."

Of course, the past is only a guide, and perhaps a poor one at that. There's also some play in how one might estimate taxes, fees and inflation. Meanwhile, an investor's expectations about the future will dominate strategic design in the here and now. On that note, we might move the debate along by asking if readers think inflation, taxes and nominal returns over the next 20 years will be a) higher, b) lower, or c) about the same? Take your time. This, after all, is a trick question.

Sun 20 May 2007

Learn to manage risk to fine-tune your investments CAUTIOUS investing - now there is an interesting oxymoron. But it is the question investors most want answering: how can you maximise returns without taking undue risk with your savings? As Henry Ford once said: "The best we can do is size up the chances, calculate the risk involved, estimate our ability to deal with them, and then make our plans with confidence." Maybe with some help, advice and better understanding, we can do even better. Perhaps the issue is appreciating how to invest cautiously. After all, if investors understand risk and its potential impact, they are likely to become less risk-averse, as they shift their behaviour towards calculated and managed risk-taking? If an investor, cautious or otherwise, understands risk, weighs it up against the returns they need, the discussion changes. What we now have is a cautious approach to investing - risk management rather than risk avoidance. It's about managing an individual's capacity for risk as the result of a better, more realistic understanding of potential outcomes. So let's start by making some simple assumptions. Investors want their money to grow more than cash, otherwise they would leave it in the bank. They are looking for returns in excess of inflation, 'real' returns over the medium to long term. They therefore need to think beyond cash and consider alternatives with better potential returns but more risk. So how do you invest for real returns? We know different assets behave differently and we also know they generate different returns over the long term. Cash, for example, is unlikely to match equities in terms of return. Equities will never offer the comfort or security of money in the bank, but over time have proved the most effective asset class in terms of generating returns above inflation.

We also have a pretty good idea what these different investment types will deliver over the long term, and by comparing current returns with these longterm expectations we can get a good idea of whether we are rewarded enough for holding this asset. If we believe we can get a better return in the future from another asset type, we take the profit, rebalance the portfolio and buy the cheaper alternative. So, could we not combine this theory to create an investment portfolio designed to deliver returns above inflation? This sounds fairly straightforward, but does it actually work in practice? Yes, it can. The tricky bit is: how do you decide what to buy, when to buy it and how much to pay for it and, the biggest question of all, when should you take the profit, sell it and buy something else? It is all about value, not price - they are not one and the same. How can an investor do this? Ask an adviser to help you construct something that best fits your capacity for risk. What may be cautious investing to you as an investor may not equate to cautious as defined by the industry. A cautious investor, for example, would find that more than half of their money would be invested in stock markets. Does that strike you as cautious? Currently, Prudential's view is that equities offer better value than property or bonds. Cash looks attractive in relative terms. The equity markets we prefer are UK European and selected Asian markets. Six months ago we would have said we particularly liked Asia, but now we are seeing this valuation gap close compared with the alternatives. Know what to expect from your money, how values may rise and fall. Most of all, understand how the investment 'engine' works. The product wrapper, whether it is a unit trust, OEIC, Isa or investment bond, is primarily there to enhance your tax position. Trusts can also be instrumental in ensuring all your energies have not been wasted. It would be criminal if, after all the effort of understanding and embracing investment strategy and portfolio planning, you created an investment solution that delivered spectacular results, only to see a tax demand of 40%. So there's more to this than getting the investment right, but it's a good place to start. Get the internal workings fine-tuned first. The bodywork might be smooth and stylish, but if the engine isn't delivering the right performance it's a very disappointing journey. Frank Morton is investments development manager at Prudential

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