CONTROLLED GREED.com

In Praise of Active Portfolio Management

As you know if you're a regular reader of Controlled Greed, I'm managing my own portfolio. The stocks I report buying on this blog are spread across my regular brokerage account and two retirement accounts. It's the majority of my liquid net worth and not some theoretical model portfolio, or some side money that doesn't really impact my finances.

I do this because I'm confident I can match or beat the S&P 500 over the long term. What is less certain, much less, is if I can perform at the benchmark of inflation plus 10%.

Why do it then? Because I find value investing intellectually challenging, rewarding in a variety of ways, and, well, a lot of fun. (I think having fun is incredibly important, BTW.)

Tom Stevenson writes in the Daily Telegraph and argues for active fund management:

So why should things be different now for active fund managers and why should investors think twice before running to the apparent safety of a passive or exchange traded fund (ETF)?

One reason is that active investors tend to do well when there is a big difference between the returns of the best-performing and the worst-performing stocks. Over the past 20 years there have been two periods when there has been a big gap between the market's winners and its losers – during the 1990 recession and again during the latter stages of the tech stock boom. In both cases, the best fund managers shot the lights out. The good news is that the difference is as high as it has been for 10 years and so, therefore, are the rewards for getting it right.

If there really is such as thing as stock-picking skill, then it's likely to be most obvious when the benefits of picking winners are greatest. During the period between 2003 and 2007, although markets rose steadily, there wasn't so much difference between the best- and worst-performing stocks and the difference between the tracker fund and the star stock-picker was far less clear.

Read the whole thing.

“In my lifetime, I haven’t seen opportunity like now”

That's a quote from Marty Whitman in The New York Times. More:

Like many value managers, Mr. Whitman’s fund has benefited from a snapback rally in financial stocks — his financial investments are located in Hong Kong. These stocks, which make up 39 percent of the fund’s $4.5 billion in assets, were down 60 percent last year even though the companies remained profitable. In the first half of this year, the stocks were up from 14 percent to 46 percent, yet they still sell at discounts to net asset value of 25 to 30 percent, according to Mr. Whitman.

The fund also has benefited from performing loans that Mr. Whitman bought in the first quarter of 2009, when they had yields to maturity of 25 percent or more. Since then, yields on his loan investments have come down to around 20 percent, but that’s still attractive, he said.

Mr. Whitman also sees opportunities in energy stocks.

In the third quarter of last year, Third Avenue Value increased its investment in EnCana, a Canadian oil and natural gas exploration company, and Nabors Industries, a gas and oil drilling company based in Bermuda, on whose board Mr. Whitman has served since 1991. Both stocks currently sell for under 10 times earnings.

And more from Whitman at the article's end:

Mr. Whitman, along with other investment managers, has tweaked the stock-picking process in response to last year’s events — he now looks for companies that do not need to turn to the capital markets repeatedly for cash. But he remains fatalistic about markets like that of 2008. “I don’t think anyone can predict when a catastrophic market will hit,” he said. “No question if 2008 recurs, we’ll still look bad."

Portfolio Performance 6/30/09

Through the first half of 2009, the portfolio gained +3.2%. This compares with the S&P 500 being up +1.8% over the same time. It is nice beating the S&P 500, but these gains are nothing to write home about because they lag a benchmark I like: the rate of inflation plus 10%.

I also think these gains could be erased going forward, since my holdings have certainly benefited from the bull rally in what remains a bear market. I could easily see a down year when all is said and done.

Here's where the portfolio stand as of June 30:

DirecTV Group              10.0%
King Pharmaceuticals      6.8%
Microsoft                        6.2%
Cheung Kong ADR           5.9%
Fairfax Financial            5.9%
EGI Financial                  5.5%
NipponKoa Insurance       5.5%
Foot Locker                    5.4%
Superior Industries          5.3%
Liberty Media
    (3 tracking stocks)      5.1%
Capital Southwest           4.7%
BCE                                4.4%
3i Group                         1.1%
Media General              Under 1%

Cash approximately 27.7%

Some notes. These figures are not audited, just me and my calculator. So if I'm off a bit, sorry.

The portfolio stretches over three accounts: my regular brokerage account and two retirement accounts. Most of my liquid net worth is in the positions above. The "Controlled Greed portfolio" isn't some little portfolio on the side. It is real money. Unless I lose it all, that is. ;-)

You'll notice DirecTV Group is by far my largest holding. It is even larger when we consider that DTV is also a major part of one of Liberty Media's tracking stocks. I may well be making a mistake by letting this position remain as is without scaling back and taking some profits. We'll see.

Fairfax Financial is a nice-sized holding. Remember that I've sold enough of this stock a while back to get my original capital out of it. The holding is a free ride.

The portfolio holds enough cash to establish 5 new positions at some point. I don't know when that will be.

I'm content with all the holdings, except for Media General and 3i Group. MEG has been a disastrous investment and represents money lost. 3i Group may fall into that category as well. Yet we'll have to see what the private equity firm does when the market comes back to make that call.

Let's see what the second half of 2009 has in store.

Five for the Weekend #48

Been more of a hectic week than busy one for yours truly. No big surprise there -- I've found over the years that the weeks before and after a holiday can be that way. Nothing can be done about that, we just work through it and work through it until normalcy  returns. Sort of like working through a bear market. In the meantime, here are five items you might wish to check out.

• Big news is that Warren Buffett thinks we might need a second stimulus. I bow to no person in my admiration for Buffett. His "Superinvestors of Graham and Doddsville" hit me like a load of bricks when I read it in 1986. I've benefited from his wisdom, think he's the greatest investor of the post-WWII era, and believe he's a great CEO. Yet, as you've read me say before, I would much rather be ruled by the late Howard Buffett than his sainted son.

• Regular Controlled Greed readers know I've long admired the investment approach taken by Jonathan of the Cheap Stocks blog. He digs for companies with hidden assets -- usually real estate but sometimes other types of "stuff." This week he announced buying a net-net, one that's a play on its stash of diamonds. You know, the things many say are a girl's best friend.

• Paul Ingrassia has written some great columns about Detroit in general and GM in particular in The Wall Street Journal. Here's his latest: "I'd like to be optimistic that General Motors will survive and thrive -- not with anything approaching its dominance of yore, but with a new effectiveness that the company has lacked for about 30 years. In truth, whether GM will last is hard to say. We're in uncharted territory. But its survival is up to the company and all its employees, including UAW members. Let's hope they make the most of their second chance." NOTE: This is on RealClearMarkets.com so it should be available even if you don't subscribe to WSJ.com.

• John Malone said this week that media companies must find a way to charge for their content on the internet. He made news by saying it may be too late for some outfits. Regular readers know I hold the three Liberty Media tracking stocks, as well as DirecTV Group (DTV) that Malone effectively controls. He's an interesting guy.

• This is an excellent -- and very long, so you might want to bookmark it -- article by Bloomberg about the death of Thailand's King Bhumibol and potential ramifications of his passing. It even has some interesting bits about Marc Faber, who lives in Thailand: "Even at 8 p.m. on a Saturday, the bar girls far outnumber customers at Bar Linda, Faber’s favored watering hole. 'A few months ago, this place would have been packed by now,' he says, gesturing down the row of near-empty bars." Great read.

Have a great weekend!

3i Group Halves Debt, Remains Cautious

Private equity outfit 3i Group PLC (III/LN) reports making progress:

"Our focus in the first quarter was on strengthening the balance sheet," Chief Executive Michael Queen said in a statement.

"A substantial increase in liquidity and the reduction in net debt provide further resilience in what remains a fragile environment."

Private equity firms have seen the value of their investments slump as falling revenues and shaky outlooks hit company valuations. And new deals have come to a virtual halt as debt to fund them has dried up.

3i has shrunk to the point of being one of my portfolio's smaller positions. But I'm not quite ready to place it in the permanent loss of capital category like I have Media General (MEG). The company could make a nice comeback when the economy turns around.

That said, I didn't take advantage of 3i's recent rights offering, which was dilutive to existing shareholders.

Correction to previous post

I meant to say I am NOT itching to buy more Asian stocks. Nothing against them, but I think several North American stocks could become bargains and managements tend to be more shareholder friendly in these parts.

I need an editor at times. ;-)

Tom Stevenson: Go East Young (Investor) Man

Asia is where young investors should put their stock market money, argues Tom Stevenson in the Daily Telegraph:

Of course, Asia is not immune to the cold draught blowing in from the Anglo-Saxon economies. There was a grain of truth in the re-coupling argument that triggered the savage sell-off of Asian risk last autumn. But the long-term case for investing in Asia remains compelling. Here are four reasons why the best advice for a young investor is still to "go East, young man".

Read the linked article for Stevenson's four reasons. Great stuff, as he typically writes, though a little to top-down for me. I say that because my Asian stocks include Cheung Kong Holdings (Hong Kong) and NipponKoa Insurance (Japan) and I'm itching to buy more. Of course, companies like Microsoft, Fairfax Financial and 3i Group have Asian exposure. And at least a couple of stocks I've been eyeballing certainly have Asian exposure -- yet could never be thought of as "Asian plays."

I respect Stevenson immensely and enjoy his Telegraph columns. But for now, this middle-aged man is focusing on North America.

Bloomberg: Microsoft Among Those Preparing for the Worst

Cautionary story by Bloomberg on a late May gathering of treasurers from America's bluest of blue chip companies:

After watching credit dry up almost overnight as the subprime mortgage contagion spread in 2007 and 2008 and Lehman Brothers Holdings Inc. collapsed in September, companies were more preoccupied with stockpiling cash and extending debt maturities by selling a record $301 billion of investment-grade bonds in the first half.

And this concerning portfolio holding Micrsoft (MSFT):

“There’s still a good deal of precautionary borrowing taking place,” said John Lonski the chief economist at Moody’s Capital Markets Group in New York, a unit of Moody’s Investors Service. “There are a number of unresolved issues regarding access to capital.”

The $3.75 billion sale May 11 by Redmond, Washington-based Microsoft was its first ever and was done even though regulatory filings show the maker of Windows computer operating systems had $25.3 billion in cash and short-term investments as of March 31.

“It’s always better to issue when you don’t have to,” said Microsoft Treasurer George Zinn. “Microsoft has been evolving its capital structure over a long period of time. This is just part of that logical evolution.”

Things are likely to get worse before they get better. Which will no doubt require a strong stomach for many holdings if (when?) the broad markets swoon. Yet Microsoft shouldn't be a cause for concern.

Barron's Forum Part II, John Hathaway Interviews

Among the interviews posted on King World News this weekend were part II of Eric King's interview with a Barron's Forum and one with John Hathway of the Tocqueville Funds.

Those Barron's guys are fun -- and just go to town all by themselves on topics. The interviewer asks a question and they bolt out of the starting gates agreeing, disagreeing, etc. Good stuff and it's a shame mainstream outlets like Meet The Press or Charlie Rose don't have folks like Thomas Donlan on.

John Hathaway was also good, and this is the first time I recall hearing an interview with him. Perhaps I've heard him on Financial Sense Online but don't remember. Back when Jim Grant was penning columns for Forbes, he reported being invested in the Tocqueville Gold Fund. Of course, that may or may not no longer be the case.

Barron's Favorable Feature on Foot Locker

The saying that value investing is like watching paint dry or grass grow is certainly true. Months and even years go by with very little to say about portfolio holdings.

One example is my position in Foot Locker (FL). I bought the stock because it had a rock-solid balance sheet. But it had made some mishaps in merchandising and I got in at what I thought was a beaten-down price. Then the Panic of 2008 hit and the stock price cratered, as did just about all my holdings (except for DirecTV and Fairfax Financial). I held Foot Locker because the balance sheet appeared to be holding up and the company pays a decent dividend.

This week's Barron's is running a favorable story on Foot Locker. Some parts:

The company handily beat analysts' first-quarter earnings forecasts, due to lower costs and a double-digit increase in average selling prices. The current quarter will be challenging relative to the year-ago span, when consumers were spending the government's stimulus checks, but the back-to-school season looks promising. Susquehanna Financial Group upgraded its rating on the stock to Positive from Neutral following the release of first-quarter results, saying it expects cost-cutting initiatives and inventory controls to prove sustainable.

And this:

Like rival Finish Line, Foot Looker also is closing underperforming stores after overexpanding in the late- 1990s. Last year it shuttered 208 units and opened 64, for a net loss of 144 stores. This year it could close up to 100 and open about 40, mostly in Europe. In the first quarter the company closed 24 units, opened 16 and remodeled or relocated 47. All told, management has reduced store count by 259 units in the past five years, and has sliced inventory by 17% in the past two years, to $1.24 million at the end of the first quarter.

That's some of the good stuff. Now the cautionary:

"A high multiple isn't warranted for a company that has comped negatively [posted comparable-store sales declines] for three years running, that is shrinking its store base, and is in an industry that doesn't really offer any growth, even if it is the dominant player in that market," says one skeptic, John Zolidis, an analyst at Buckingham Research Group.

The path to earnings gains, Zolidis says, must come from sales. His Underperform rating and a price target of 9, however, suggest he is doubtful Foot Locker can achieve meaningful sales increases in this "difficult retail climate."

Yet I remain a holder for now:

Hicks will be helped not only by the savvy moves his predecessor made, but by Foot Locker's rock-solid balance sheet, which boasts about $400 million in cash -- or $289 million, net of debt. The company's ability to keep generating the stuff has enabled it to pay a dividend of 60 cents a share, for a generous yield of 5.8%.

The economy could get worse before it gets better. Keep that in mind. It could be a while before this stock pays off. If it ever does.

Five for the Weekend #47 -- July 4th Weekend Edition

With Saturday being Independence Day here in the US, Controlled Greed is declaring victory and taking Friday off. We hope all our Canadian readers enjoyed a great Canada Day on Wednesday. Here are five items you might wish to check out over the next three days.

• The jobs report was a downer, showing US unemployment at 9.5%. The Lex take in the Financial Times: "This is a volatile measure. But if the disheartened are only now ceasing their search for work, that suggests a drawn out period in which they rejoin the labour force, lifting the unemployment rate. And they are right to be discouraged: the mean duration of unemployment is rising, points out Forward Capital, while at 54 per cent, the proportion of the unemployed permanently, rather than temporarily, laid off is at its highest since records began." In all fairness, President Obama cannot be saddled with this (sorry to all my conservative friends). At least not yet. My hunch is the economy doesn't become his until 2011 and 2012. I just wish he was as fair to bond holders.

• Alice Schroeder writes on Bloomberg about promoting her Warren Buffett biography in China: "It is just as strange that Buffett, the man of patient capital accumulation, has been so fetishized in China, the land of instant everything. The tour gave me a window into the attitude of Chinese investors. It resembled no book tour imaginable in the U.S., consisting of marathon two-plus-hour press conferences and six-hour “forums” (a speech of at least 60 minutes, followed by a panel, then audience questions and answers followed by a book signing and a banquet) in Beijing, Nanjing, Shenzhen, and Shanghai."

• I don't own Johnson & Johnson directly. Prem Watsa has raved about the company so I assume Fairfax Financial (FFH) still holds stock in the healthcare giant. I recently linked to a Barron's Online article claiming Johnson & Johnson was attractively priced. Now Barron's is running another article giving thumbs-up to the company acquiring Irish drug maker Elan.

• Matthew Lynn writes in The Spectator about the three-generation feud between German auto makers Porsche and VW. A bit: "Both trace their origins to one of the most brilliant industrial designers of the 20th century, Ferdinand Porsche, who was an engineer in the 1920s for Daimler-Benz — which turned down his plans for a small city car, preferring to concentrate on upmarket Mercedes limousines. Hitler was more impressed, however, and asked Porsche to design the Beetle, the ‘people’s car’ that launched Volkswagen. Over the next few years, he came up with other nifty vehicles for the Führer, such as the Tiger tank which made its debut on the Eastern Front in 1942. But it was the Beetle that was his enduring triumph."

• Mark Steyn may be the best obituary writer in the English language (he also used to write great movie reviews in The Spectator). Here's his take on Michael Jackson.

Well, that's it for now. Happy July 4th to everyone in the US. And for readers everywhere, the hunt for value enters the second half of 2009.

Barron's Forum, Jim Puplava Interviewed on King World News

Eric King continues his run of top-notch interviews on his site, King World News. This weekend included talks with a Barron's Forum -- including Tom Donlan, Randall Forsyth and Gene Epstein. Another interview was yet another discussion with Jim Puplava.

Part II of the Barron's Forum is scheduled for this coming weekend.

Southeastern Asset Management Loses in Attempt to Replace NipponKoa Insurance Chief Executive

I should have posted this at the end of last week, but time got away from me.

Southeastern Asset Management, famous for its Longleaf Partners family of funds, owns 17% of NipponKoa Insurance. This is the second year running that Mason Hawkins and gang have been unsuccessful in replacing the CEO. I doubt they thought they had a shot -- more likely just registering disapproval on direction.

After their first attempt last year, NipponKoa announced plans to merge with Sompo Insurance Japan, a move which Southeastern Asset Management supports.

Everything You Ever Wanted to Know About Gold -- and More

If you've got some time on your hands and looking for some interesting reading on this Monday, check out The Privateer Gold Pages.

They're written by Bill Buckler, publisher of The Privateer market letter based in Queensland, Australia. You'll read some fascinating stuff about gold, the history of gold, money and a whole lot more.

My hunch is that you'll find this worthwhile -- even if you don't share Buckler's views on gold or believe gold is the only honest money.

This is every bit as long as it is interesting, though. So you might want to bookmark the site for later reference if you've got things filling up your time right now.

Five for the Weekend #47

If you live in the US, you're probably amazed -- but not surprised, certainly -- how our three 24-hour so-called news channels can instantly turn themselves into the E! Channel. Oh well. In the meantime here are five items for your review this weekend.

• China reiterates its call for a new world reserve currency: “Zhou Xiaochuan sees the current international financial system is flawed, putting too much emphasis on the dollar as a reserve currency,” said Kevin Lai, an economist with Daiwa Institute of Research in Hong Kong. I'm not a gold bug, but I do believe gold is the honest form of money. But Central Bankers and governments will fight it to the death.

• The Lex Column in the Financial Times points out the the King of Pop was also a King of Debt. In some ways, Michael Jackson's death reminds me of Elvis' in 1977. Both in poor health at relatively young ages, finances in poor shape, hangers-on existing like leeches on their host and abuse of pain medications. Back to Lex: "They say the rich are different, but it is the famous who are really different. The merely wealthy would have gone bankrupt long ago. Even faded stars such as Jackson can stay afloat with the promise of income from comebacks like his now-aborted concert series." The Elvis estate made a spectacular financial comeback, and look for Jackson's to do the same. R.I.P. Mr. Jackson.

• At the risk of sounding crass, while on the subject of painkillers, portfolio holding King Pharmaceuticals (KG) this week announced it expects regulators to delay sales of the first short-acting oxycodone pill designed to deter abuse. The stock fell on the news, but its only a few cents below my entry price. So I'm not in any pain...yet.

• Africa-Asia Confidential runs an in-depth profile of China's role in the power-sharing negotiations inside Zimbabwe. China's increasing bilateral trade with African countries is one of the most interesting -- and unreported, at least here in the US -- stories in our time.

• Free Money Finance, a great personal finance blog, has an interesting post on whether women should marry for money. FMF links to a WSJ.com blog post. Good link, good FMF post, and I enjoyed reading the commenters on FMF. Maybe you will, too.

Have a wonderful weekend, folks!

Fairfax Financial Twofer Thursday

Two items of note regarding portfolio holding Fairfax Financial (FFH) today.

First is news that the SEC has completed its investigation, with no action being taken:

Fairfax was subpoenaed in 2005 and 2006 by the SEC regarding its non-traditional insurance or reinsurance transactions and comments Watsa made in response to a question during an investor conference call.

Second is this Globe and Mail blog piece including Fairfax in its list of stocks on the Toronto Stock Exchange with "wads of cash in their back pockets." This was actually posted last night, but what the heck, I saw it today:

The “net cash per share” screen is just one tool used by value investors looking for investment opportunities in companies whose shares have sometimes been under sustained selling pressure.

The formula for net cash per share is the total value of all cash and equivalents less the total of the short- and long-term liabilities divided by the shares outstanding. The net cash per share is then expressed as a percentage of the current price.

Interesting article -- interesting list of companies.

Warren Buffett Wednesday

The big news on Warren Buffett today was the interview he gave to CNBC on the lousy state of the economy. His statements echo those of the Barron's Roundtable participants a couple of weeks ago, who were downright, well, down on business conditions.

And when the CEO of Verizon appeared on Charlie Rose the other night, they spent most of the time talking about communications. Towards the end Rose asked about the overall state of the economy, and the CEO (name escapes me) seemed to be bending over backwards not to be too negative. Yet maybe that's just what I sensed and reading the transcript would give a different impression.

More interesting is this WSJ.com piece on Warren Buffett's portfolio holdings being cheap.

My take is that it might be better to just buy Berkshire Hathaway. BUT I wouldn't pay any "Buffett premium" -- and may only buy if Berkshire traded at a nice discount to NAV. Perhaps I'm being too greedy in that view. I just like it when I can buy big conglomerates like I bought Cheung Kong Holdings earlier this year -- at a 70% discount to book. I know. I know. Not exactly an apples-to-apples comparison.

Will Berkshire ever trade that cheaply? Doubtful. And I'm not holding my breath.

Japanese Retail Investors Turning on Managements?

According to Bloomberg, 78% of all retail investors in Japan who are planning on voting are prepared to cast ballots against managements.

This section in particular catches my eye:

Southeastern will vote against the re-election of NipponKoa Insurance Co. President Makoto Hyodo at the insurer’s shareholder meeting scheduled for June 25, the fund said in a statement in March.

It would be the Memphis, Tennessee-based fund’s second attempt to oust Hyodo. Southeastern, which has about 17 percent of the casualty insurer, has cited his failure to raise shareholder value. Nipponkoa shares have slumped 19 percent this year, compared with a 6.7 percent decline by the nine-member Topix Insurance Index during the same period.

Southeastern’s unsuccessful bid last year contributed to Nipponkoa announcing cost cuts and a plan to merge with Sompo Japan Insurance Co. amid declines in premium income.

You'll recall I mentioned NipponKoa earlier this month. The company is a legacy holding of mine, since I purchased Koa Fire & Marine Insurance back in 1998.

Breakingviews: Market Turning, Green Shoots Mowed Down

Regular Controlled Greed readers know I respect the editors of Breakingviews.com immensely. The top guy, Hugo Dixon, oversaw the Lex Column at the Financial Times before launching BV some years ago.

So when they put out a piece like this one, I sit up and pay attention:

Falling copper prices, a World Bank report questioning global growth, talk of currency trouble out east in Belarus were all possible triggers. But the results were plain to see. Equities, oil and other commodities were hit brutally, as well as recent market darlings such as the Australian dollar and the Brazilian real. The US dollar muscled in like a new enforcer.

Further down:

But now the hopes and the stimulus are being questioned. Wednesday will be important. The US Federal Reserve is expected to confirm the markets' broad expectation that it does not plan to print yet more money. There may even be Fed intimations of an 'exit strategy' from stimulus. Less money printing should be good for the dollar - but is potentially very bad for commodities, currencies and equities that have scampered ahead on pumped cash, a frail dollar and reflationary hopes.

And finally:

Meanwhile, central bankers are warning governments about fiscal stimulus, which has gone over its limit in the US and UK. That leaves the markets to reassess a world showing only meagre signs of economic recovery but with prices that have leaped ahead in just months. The risk is that Monday's shoot-out is the first of many until more rational levels are reached. After the merry months, the forensics could be kept busy for a while.

Hate to say "everyone knows." Yet everyone should have known this has been a bear market rally. The question is now: did it end Monday?

Looming Energy Plays?

John Dorfman expects energy stocks to surge when the recession ends:

Energy stocks may be especially timely now. They usually do quite well after the end of a recession.

No one knows when the current recession will end. A few months ago, most economists were guessing 2010 or 2011. Today, many are predicting it will end this year -- a view I share.

I examined the performance of three energy indexes after the end of the past five recessions. By my calculation, oil drilling stocks rose 22 percent on average over the ensuing 12 months. Oil exploration and production companies gained 13 percent, and integrated oil companies 9 percent.

By comparison, he reports the S&P 500 averaged a gain of 8%.

I've actually been thinking of some energy stocks -- particularly oil and gas related companies. But I've got to do a lot more research before putting any money to work there.