November 2012 Review

Portfolio Update

There were a couple of changes to the portfolio during the month: 

- The position in Treasuries (TLT) was closed during the month.  The position has been the largest contributor by a substantial distance since the launch of the portfolio, but with 30-yr yields near 2.75% the near-term seems to pose greater risk than potential reward. 

- The portfolio’s position in Gold (GLD) was increased during the month.  While, Our Man is somewhat skeptical over any substantial and permanent long-term Gold price appreciation, the position offers some short-medium term opportunity based on favourable technicals and as a hedge against political & central bank stupidity. 

- As mentioned in an earlier post this month, the NCAV book was increased through the addition of some new positions that met the book’s criteria.

Performance Review 

November proved a relatively quiet month for the portfolio, which fell 13bps to leave the YTD performance at -1.6%. 

The month saw most of the books post small losses, which were partially offset by some larger gains.  The Puts/Hedges book (-3bps) and China thesis (-3bps) books posted small losses as the time decay continued to reduce the remaining value of the puts.  The Currencies (-5bps) book also posted a small loss during the month, with speculation continuing on future of the Euro and the path that the countries will take.  The Value Equities (-2bps) and Energy Efficiency (-10bps) books posted small losses as there was little in the individual company reports to substantially driver performance.  Gold (-11bps) was also a negative contributor during the month.

These losses were largely offset by performance from the Treasury book (+10bps), and also from the NCAV book (+12bps) where both the existing and new names helped performance.  The Bond Funds (-0bps) had no impact on performance.

Portfolio (as at 11/30 - all delta and leverage adjusted, as appropriate)  

19.6% - Bond/Absolute Return Funds (DLTNX and HSTRX)

13.1% - Precious Metals (GLD)

6.0% - Value Idea Equities (THRX, and DRWI)

2.4% - Energy Efficiency (AXPW, and XIDE)

1.7% - NCAV Equities

0.0% - Other Equities (none)

-0.0% - China-Related Thesis (3bps premium in EWZ Jan-13 puts)
-0.0% - Hedges/Put Options (less than 1bps each in IWM Jan-13 puts, SPY Jan-13puts, XLY Jan-13 puts)

-11.8% - Currencies (EUO – Short Euro)

51.3% - Cash 

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (DLTNX, HSTRX, GLD, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

NCAV 2012-2

It has been a long time since the first NCAV update of the year, but this represents the process failing to show up any names that could be added to the Absolute Value/NCAV bucket portfolio (for information on this bucket, and how it works, read here).

As reminder, the initial screen is a valuable tool but from its list of potential positions, a number of names are removed after a simple qualitative overlay.   The conceptual reason for this quantitative overly is ensure that the data used by the NCAV screen as an input is of suitable quality, and that the results are thus meaningful.  A fuller explanation of some of the reasons why names are removed after this qualitative overlay can be found in the earlier update from this year.

The NCAV screen (run on 11/25) produced 2 new positions;
- Imation Corp (IMT), a c$160mn market cap company.  Based on its Q3-12 report, 65% of the company’s Net Current Assets (=Current Assets - Total Liabilities) was $185mn.
- Radioshack (RSH), a $190mn market cap company.  Based on its Q3-12 reports, 65% of its NCAV was $225mn.
As a result, both of these positions were added to the portfolio.

The one existing name in the portfolio (TWMC), no longer qualified for the screen and thus the final date that this name must be sold by was not extended (here are the rules when NCAV names are sold).  

Things from my Google Reader: Nov-12 Edition

Well, with the Holiday Season upon us, what better time to update you some things that Our Man read over the last couple of months.  There's a special US Election-related section, at the end, since I couldn't quite hold my tongue entirely 

- America’s Slippery Slope into Britishisms!

Can I take credit for this?  Did Goldman Sachs’ (allegedly) prevalent use of the word ‘muppet’ to describe clients in London lead to this article?   Or are American’s finally accepting that Brits just do the whole colloquialism/slang thing vastly better!  (Alex Williams, New York Times) 

- The Birth of Bond

Continuing our British-theme, what could be more British than James Bond?  Well, excluding some of Daniel Craig’s dubious pronunciation in Skyfall - no doubt it was for the benefit of a US audience – didn’t they read the above NY Times article!  On that note, Our Man saw SkyFall last week, loved it and heartily recommends it if you liked Casino Royale (but somewhat less so if you preferred anything Roger Moore/Pierce Brosnan!  There’s no accounting for taste!).  (David Kamp, Vanity Fair) 

- Show Me The Money

After long being the red-headed stepchild of economics, behavioural economics is now being used more than every (especially in the US and UK) to shape policy and bend its impact.  Here, Professor Cass Sunstein’s talks about its development and impact on policy (especially consumer protection).  (Cass Sunstein, The New Republic) 

NB: You may want to try the experiment in this video, before reading the article! 

- The Hunt for “Geronimo”

Mark Bowden’s adaption from his forthcoming book, detailing the process, research, preparation and decisions behind the Administration’s decision to green-light the raid on Osama bin Laden.  (Mark Bowden, Vanity Fair) 

- When The Growth Model Changes, Abandon theCorrelations

Professor Pettis describes why he thinks a lot of the current research on China’s GDP growth over the coming decade is flawed.  He also considers why Japan in the late 80’s is a better comparable to the China of today, than the more often mooted Japan in the 70’s.

(Michael Pettis, on his website and also at Credit Writedowns) 

Election Fever

Things that amused and interested me about this year’s US Presidential election.
- That (as Mark Cuban noted, post election) the multi-millionaire CEO who was running built an organization that was technologically inept (and had no back-up plan), was inefficient in its expenditures (purchase of ads) and never tested its core assumptions.
- Sasha Issenberg being right beforehand, and Alexis Madrigal subsequently adding much more colour, about how the President’s team was creating the first truly 21^st century campaign, and utilizing data efficiently and effectively (i.e. like they do in the private sector).
- That systematically using data (whether it was 538, RCP, Pollster, or my personal favourite Votamatic) was more helpful than using your “gut” and paying little attention to the data (Karl Rove, George Will, DickMorris, etc).  And that people were then shocked by this!
- That the ‘auto bailout’ was deemed  a major factor in helping the President win re-election.  That's fair enough, but it's strange how nobody points out how universally unpopular the bailout was, even in Michigan, back in 2009 when the decision was made!  
- That Democrats think that demographics and data mean the future is theirs.  As ErickEricksson noted within a pretty thoughtful and insightful piece (especially given it was barely a couple of hours after the Republicans had lost the White House) on the election and the conservative movement, it’s yet to be proven that Obama’s coalition is a Democratic one (as opposed to just an Obama one).

October 2012 Review

*Post updated 12/1, to reflect some inaccuracies in the performance figures of the individual books (the overall performance, exposure information, etc was unchanged).

Portfolio Update
- There were no changes to the portfolio during the month.

Performance Review
The portfolio fell, together with the market, during October losing 1.12%, which leaves the book -1.51% YTD.

The moves in the Treasury book (-1bps) and the Bond/Absolute Return book (+2bps) largely cancelled each other out, as Treasuries widened during the month while other bonds (especially mortgage-related) tightened in October.  The Energy Efficiency (-4bps) and NCAV (-4bps) books posted incremental losses, as they fell with the markets.  The Precious Metals (-23bps) position was a negative contributor.  The Currencies book (-11bps) hurt the portfolio, after the Euro strengthened following continued signs that the politicians and bankers are prepared to support the currency and the member nations that run into fiscal problems.

The Puts/Hedges (-2bps) and China Thesis (-10bps) strategies both suffered in spite of the falling market due to the cost of the time decay outweighing the benefit of the various options being closer to profitability.  While the falling market brought both books closing to being in the money, they remain some way out of the money (20%+) and thus suffer from a rapidly declining probability of being profitable. 

The primary detractor was again the Value Equities (-58bps) book, with the losses from the position in THRX offsetting the much smaller gains in DRWI.  Despite the difficult markets, Dragonwave (DRWI) rose over 10% after announcing its Q2 number during the month and guidance that suggested the integration of the division it recently purchased from Nokia was going well and that the firm was likely to be break-even by its fiscal year-end.   In contrast, Theravance (THRX) fell over 15% during the October, which means that the position has given up the majority of the gains it made since it announced Glaxo taking a larger stake and the positive progress of their key drugs back in June/July.  There has been limited news since then meaning that market fears over the success of these drugs has returned, and this has been compounded by Glaxo’s weak results which means people feel it’s less likely to bid for THRX (in which it owns a 20%+ stake) in the short-medium term.

Portfolio (as at 10/31 - all delta and leverage adjusted, as appropriate) 
19.6% - Bond/Absolute Return Funds (DLTNX and HSTRX)
7.5% - Precious Metals (GLD)
6.0% - Value Idea Equities (THRX, and DRWI)
5.1% - Treasury Bonds (TLT)
2.5% - Energy Efficiency (AXPW, and XIDE)
0.6% - NCAV Equities
0.0% - Other Equities (none)

-0.7% - China-Related Thesis (6bps premium in EWZ Jan-13 puts)
-0.1% - Hedges/Put Options (2bps in IWM Jan-13 puts, 2bps in SPY Jan-13 puts and <1bps jan-13="jan-13" puts="puts" span="span" xly="xly">

-12.1% - Currencies (EUO – Short Euro)

52.7% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, GLD, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

September 2012 Review

Portfolio Update
- There were no changes to the portfolio during the month. 

Performance Review
The markets continued to rise during September, as Central Banks globally showed their willingness to provide plentiful cheap liquidity.  Unfortunately, the portfolio caught little of this upswing and ended the month down 54bps, tipping it back into slight negative territory (-0.4% YTD) for the year.

For the most part, the book behaved largely as expected given the market conditions.  The Treasury Book (-9bps) suffered as investors showed an increased willingness to take risk, though the Bond/Absolute Return Funds (+13bps) benefited from this as other types of credit and equities generated positive returns.  The books that were short equities, the China Thesis (-13bps) and Puts/Hedges (-16bps), both lost money as the market rallied.  On the positive side, many of the books that were expected to gain from QE3 and the other pledges of liquidity , largely did so, with the NCAV (+5bps), Energy Efficiency (+3bps) and Precious Metals (+20bps) all helping the month’s returns.

The portfolio’s negative performance largely stemmed from 2 books, whose performance disappointed during the month.  The Currencies book (-26bps) gave back gains from recent months, despite renewed signs of problems in Greece and Spain that may require bailouts, as the optimism over the Euro-countries staying together generated by Mario Draghi’s pledge to do what was necessary continued.  More disappointingly, the Value Equities book (-31bps) hurt the portfolio despite the rise in equity markets.  Almost the entire loss came from the position in DRWI, which fell 15% during the month; while the company guided its revenue projections above analysts’ expectations for its Q2, it failed to offer any guidance for the balance of the year.  This added yet greater uncertainty to the stock, though shouldn’t be entirely surprising given their recent acquisition of Nokia-Siemens’ Microwave Transport business which will represent a substantial part of the company going forwards.

Portfolio (as at 9/30 - all delta and leverage adjusted, as appropriate)
19.3% - Bond/Absolute Return Funds (DLTNX and HSTRX)
7.4% - Precious Metals (GLD)
6.2% - Value Idea Equities (THRX, and DRWI)
5.1% - Treasury Bonds (TLT)
2.6% - Energy Efficiency (AXPW, and XIDE)
0.6% - NCAV Equities
0.0% - Other Equities (none)
-0.7% - China-Related Thesis (25bps premium in EWZ Jan-13 puts)
-0.1% - Hedges/Put Options (5bps in IWM Jan-13 puts, 4bps in SPY Jan-13 puts and 3bps XLY Jan-13 puts)

-12.0% - Currencies (EUO – Short Euro)

52.2% - Cash 

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, GLD, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

Things from my Google Reader: Sep-12 Edition

With summer ending, and Autumn beginning, here’s some things that Our Man read over the last couple of months.  As per normal, the articles become more serious the further you manage to get through this post!  With that in mind, why not start off with some Sports News!

Sports News 
- The London Chronicles: Great Britain Lives Up to its Name! 
The Olympics were held in Our Man’s home town this year, and after a slow start Team GB exploded into life on "Super Saturday".  Even American uber-sports writer Bill Simmons was impressed. (Bill Simmons, Grantland)

- RA Dickey Has Straightened-out His Life and Crooked-out His Pitches 
The most interesting man in baseball, and one of the (very few) bright spots on a very mediocre (and apologies to the word mediocre, for the insult!) Mets team!  Bizarrely, it’s not hyperbole to ask if the only man in the world currently capable of throwing a knuckleball at a Major League-level is about to be declared the best pitcher in the National League this season!  (Dave Sheinim, Washington Post)

- Cosell Talks: Eli’s Arrived 
Finally, with Football season kicking off, what better time to reminisce in the happy ending to last year’s season and Super Bowl  XVLI.  (Greg Cosell, NFL Films)  

And In the Real World 
- How Apple & Amazon Security Flaws Led to my Epic Hacking 
If (for some unbeknownst reason) you don’t have a two-step verification process for your email, then this article will inspire you to get one…quickly!  A look at how simple it is for someone to take over your online life and all of your accounts, while knowing minimal data about you.  It also says rather a lot about the poor controls at Amazon & Apple (amongst others), and how little they value your data.  The author, who’s technologically far more savvy than Our Man, did manage to get his digital life back!  (Matt Honan, Wired)

- A Critic's Manifesto: The Intersection of Expertise & Taste
A critic's view of what a critic should do, or least aim to do. (Daniel Medelsohn, The New Yorker) 

- The Weasel, Twelve Monkeys And The Shrub
Since it's election season, and Our Man doesn't talk politics, here's some political reading for those of you that need your election fix.  A David Foster Wallace's article from his time on John McCain's campaign bus, back in 2000!  A more interesting and far better read, than anything you're likely to see that's a little more 2012-relevant!  (David Foster Wallace, Rolling Stone...though since I couldn't find a copy on their website, this one is from Txt Post)

- The NSA is Building the Country’s Biggest Spy Center 
Now Our Man and Mrs. OM are fans of the CBS show “Person of Interest”, which is based around a government program that tracks all of our communications, which a former CIA agent & a computer genius-type guy use the information from to try and help prevent crimes.  Who knew that it’s all rather closer to the reality than fiction!  (James Bamford, Wired) 

- China: Shadow Bankers Vanishing Leave China Victims seeing Scams 
Yup, China, again!  Our Man may seem like Chicken Little, but it is stories like this, and their ever increasing prevalence, that should be worrying to folks!   Credit is (unfortunately) the key building block of modern-day economies, and there ever increasing signs that the underlying collateral is either over-valued or doesn’t exist (i.e. Ponzi finance)!  You saw what happened in the US, when supposedly good collateral (housing) was significantly over-valued…now imagine vast reams of it not existing!  (Bloomberg News)

- Roberts Switched Views to Uphold Healthcare Law 
I don’t much care if you think the Healthcare Law is good, bad or indifferent, I just thought this was the best reporting of the Supreme Court’s decision and what went on behind the scenes.  Given the paucity of actual reporting (as opposed to opinion masquerading as such) in the press these days, it’s worth acknowledging.  (Jan Crawford, CBS News)

August 2012 Review

Portfolio Update
- As noted in the recent “After Half-Term Ponderings” it seems that we’re set for QE Everywhere.  With the portfolio positioned poorly for this, Our Man added a position in Gold (GLD) for a 6-12month ‘trade’.

Performance Review
Despite August proving a positive month for the markets, the portfolio fell by 64bps during the month once again leaving the portfolio around flat (+0.15% YTD) for the year.

The fund spent the entire month in the red with the losses being fairly broadly spread across the portfolio.  The Puts/Hedges (-21bps) and China Thesis (-11bps) books both suffered as markets across the globe rallied, with both now representing very limited exposure.  The Currencies book (-29bps) gave back most of July’s gains, with almost the entirety of the loss coming after ECB President Mario Draghi pledged to do everything to support the bond markets (especially those in Spain/Italy) and keep the Euro together.  The Treasuries book (-7bps) also gave back part of its recent gains.  Finally, despite the general rise in equities, the Value Equity book (-32bps) was also a negative contributor.  This was due to the fall in THRX, which saw some profit-taking following its 25%+ rally during July, and despite a positive contribution from DRWI.

The positive contributions were all relatively small.  The Absolute Return/Bond Funds (+13bps), NCAV (+5bps) and Energy Efficiency (+8bps) books both benefited from the rise in risk appetite and asset markets.  The addition of the GLD position, meant that the Precious Metals book (+10bps) proved to be well-timed with expectations for QE3 rising after Fed Chairman Ben Bernanke’s speech at Jackson Hole

Portfolio (as at 8/31 - all delta and leverage adjusted, as appropriate)
19.1% - Bond/Absolute Return Funds (DLTNX and HSTRX)
7.3% - Precious Metals (GLD)
6.8% - Value Idea Equities (THRX, and DRWI)
5.2% - Treasury Bonds (TLT)
2.5% - Energy Efficiency (AXPW, and XIDE)
0.6% - NCAV Equities
0.0% - Other Equities (none)

-1.0% - China-Related Thesis (34bps premium in EWZ Jan-13 puts)
-0.1% - Hedges/Put Options (8bps in IWM Jan-13 puts, 7bps in SPY Jan-13 puts and 4bps XLY Jan-13 puts)

-12.4% - Currencies (EUO – Short Euro)

51.8% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, GLD, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

After Half-Term Ponderings

After a flat first half, there’s not a vast amount to analyze with regards to the portfolio’s performance.  As such, this year’s half-term ponderings will focus on some (half-formed?) thoughts that have been germinating in my mind. 

- More QE – everywhere?

While the summer has largely been very quiet, the one thing that stands out is the increased likelihood of more quantitative easing or stimulus across the globe.  We’ve had the continual hints of QE3 from various Fed doves, and the market remembers Bernanke’s 2010 words at Jackson Hole that signaled QE2 while it waits for him to speak at the same venue on Friday (my guess is he’ll talk the market up, but we won’t see QE3 enacted till December’s Fed meeting).  More surprising was ECB President Mario Draghi’s July promise to “do whatever it takes” and claims that this action “will be enough”.  This being Europe, it goes without saying that “whatever it takes” depends on what country you’re from and the political dance matters as much as the promises; we wait to see what the reality of Draghi’s promise is and whether it’s enough.  Finally, there’s China where the data continues to come in weak, which has led to hopes of another 2009-style round of investment spending and stimulus.

Frankly, the fact we’re now discussing yet another round of QE should be sign to the Fed that they’re pushing on a string and that the previous rounds have failed at stimulating any sustainable growth.  However, I’m sure they feel the need to do something and the world of the counter-factual (“imagine how much worse it would be without QE1/2/Operation Twist/etc”) that they inhabit no doubt provides reason enough to try more unorthodox policy in the hope something works.   It’s no surprise that I’m skeptical about there being any medium-term benefits (despite the long-term costs).  However, with global QE/stimulus seemingly coming and the portfolio not particularly well positioned for it, Our Man’s added a little Gold as a 6-12month ‘trade’. 

- Has the Fed succeeded, at least on one psychological level, by turning everything into a yield asset?

While there’s much debate over the whether QE1/2/Lite, Operation Twist, et al have succeeded in generating any sustainable economic growth, they have succeeded in getting investors to focus on yields.  This is evident across markets, from the obvious places such performance of Investment Grade bonds (LQD: +9% YTD) and High Yield (JNK: +7.5%) to the keen focus on dividend yield stocks and on potential rental yields in the housing market.  By persuading investors to reach for yield, and kindling their animal spirits the Fed’s moves can be seen, so far, as a success by helping to drive a range of asset prices higher and endowing people with the wealth effect.

The problem, of course, is that by encouraging investors to “reach for yield” the Fed is also trying to persuade them to focus on return on capital rather than return of capital, and thus take more risk.  What do I mean by this?  Let’s take the simple examples: much has been written about how “cheap” stocks are, either due to their earnings yield (inverse of P/E) or their dividend yield.  As these yields compare very favourably to the low yield on a 10-year Treasury, the argument goes that one should own stocks.  After all, a 10-year Treasury yields a mere 1.6%, why wouldn’t you want to own the S&P 500, which has a 2.1% Dividend Yield, instead.  The answer of course lies in the risk you’re taking to earn those yields, or more simply – bond math matters.  In bond-world, a major risk metric is duration which simply tells you the weighted average of the time that the cash-flows from an asset are received.  For a 10-year Treasury bond this figure is between 7-8years, for the S&P based on the dividend yield it is 30-40years, hence in the world of bond-math you’re taking 4-5x the risk to own the S&P.  Suddenly, that extra 50bps/year of extra yield doesn’t quite look as attractive… 

- Earnings: But what about the margins?

Our Man has long been surprised at the resilience of corporate profit margins, which have hovered around historic highs for the l2mos and whose strong bounce-back from 2008/9 has driven Earnings-growth and been an important contributor to the rally in stocks.  Interestingly, we’re now starting to see Earnings-growth falter for the first time post-2008, with YOY Earnings growth turning negative in Q2-2012. 

This fall has also started to impact analyst projections for the upcoming quarters, which have steadily fallen throughout the year. 

Given the falling Earnings, and with margins at historic highs, it means that the market is relying on either multiple expansion or the quick reversion of this trend to help it go higher.  That should sound a note of caution to investors.

- Ideas: what’s Our Man looking at?

As is traditional a little note/insight, albeit brief this time, into some of the new things that Our Man is pondering and spending his free time looking at.

a). Europe:  There are signs, like this Global Shiller/CAPE analysis by Mebane Faber, that Europe is approaching the boundary being potentially very cheap.  While a number of European countries certainly look cheap comparative to other OECD nations, Our Man is keen on looking at them versus their own history before declaring them absolutely cheap and looking to invest.  Given Our Man is limited to US-listed positions, any future positions will largely be ETFs or potentially some ADRs.

b). Possible Puts/Shorts:  Generally, Our Man can only short using puts and predominantly has to use ETFs to get his exposure.  That said, I’m looking at few things that might be interesting.  The fall into two main buckets; (i) Stocks which have benefited as investors chased yield and may offer opportunity if the dividend isn’t as secure as it seems on the surface (areas of interest include REITs and some Consumer Staples/Telecoms), (ii) stocks where the drivers of growth are misunderstood or where the forward-looking expectations are particularly unrealistic (the two names, in particular, that have drawn Our Man’s interest are Lulu Lemon and Tesla, although Apple is, or rather one-day could be, potentially particularly fascinating)

July 2012 Review

Portfolio Update
- There were no changes to the portfolio during the course of July.

Performance Review
July was a decent month for the portfolio, which rose 80bps putting the YTD performance back into the positive (+0.8%) though this pales in comparison to equity indices globally (S&P 500 TR: +11.0%, MSCI World +7.7%).

Continued concerns about the macro conditions in the US helped the Treasury Bond (+19bps) and Bond/Absolute Return (+15bps) buckets perform solidly.  This was compounded by the continued struggles of Mediterranean Europe, which saw the Currencies book (+34bps) add to performance as the Euro weakened.  This uncertainty was met with increased belief that monetary authorities across the world (especially Europe, US and China) were willing to engage in further QE (or fiscal stimulus in China’s case) and the resultant rally saw the aforementioned books give back much of their gains before month-end, and also hurt the China-related (-15bps) and Puts/Hedges (-9bps) positions.

The performance of the Equity-related books was quite mixed.  In the Value Equity book (+69bps), Dragonwave (DRWI) continued to negatively impact performance; while the company completed its business transforming acquisition of Nokia Siemens Network’s Microwave Trasportation business, the short-term prospects continue to reflect difficulties with the company issuing revenue guidance beneath analysts estimates for next quarter.  This negative performance was offset by another strong month from Theravance (THRX) – the company’s results were in-line with expectations, and the progress of their key drugs continues to be positive.   The Energy Efficiency book (-32bps) was a negative contributor, as analysts worried about the strength of XIDE’s earnings given the weakness in Europe and their sizeable business there.  The NCAV book (-2bps) is a solitary position at this time, and had limited impact on the portfolio.

Portfolio (as at 7/31 - all delta and leverage adjusted, as appropriate)
18.9% - Bond/Absolute Return Funds (DLTNX and HSTRX)
7.1% - Value Idea Equities (THRX, and DRWI)
5.2% - Treasury Bonds (TLT)
2.4% - Energy Efficiency (AXPW, and XIDE)
0.5% - NCAV Equities
0.0% - Other Equities (none)

-2.1% - China-Related Thesis (44bps premium in EWZ Jan-13 puts)
-0.4% - Hedges/Put Options (16bps in IWM Jan-13 puts, 12bps in SPY Jan-13 puts and 11bps XLY Jan-13 puts)

-12.9% - Currencies (EUO – Short Euro)

58.6% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

June 2012 Review

Portfolio Update
- June saw the second (much smaller) tranche of the redemption discussed in April, with Our Man again deciding to reduce the cash position slightly and concentrate the exposure into the existing portfolio.

Performance Review
The markets bobbed around without any clear and consistent trend for the vast majority of the month before rallying strongly in the final days, after the latest European summit seemed to suggest another plan to ‘fix’ things.  The month was a different one for the portfolio, which various elements moving in different directions as some idiosyncratic company-related events largely made up for the broad under-performance of the more macro-related elements.  The end result however was rather flat performance (+0.07% in June), which pretty much summed up the first-half of the year (-0.01% YTD)

Unsurprisingly, given the sharp rally in the market and the late-in-the-month positive sentiment towards Europe the Puts/Hedges (-56bps), and the Currencies (-32bps) books were the main negative contributors.  The China Thesis (-39bps) also hurt performance, with hopes of a soft landing in China and the potential for recovery in Europe (China’s largest export market) working against the book.

Against this, the equity-centric books were the positive driver’s of performance.  The Value Equities (+61bps) book was aided by the constructive market environment, with THRX benefiting from the positive sentiment in the biotech/healthcare space which saw a number of transactions, including GlaxoSmithKline’s completion of its acquisition of 10mn shares in THRX that was announced in April.  The Energy Efficiency book (+77bps) was the largest contributor to the portfolio.  The book was driven by the performance in XIDE, which announced reasonable numbers.  The company has a checkered history with constant Given the company’s terrible history of restructuring and constant charges the company rightly trades at a discount to peers; however, the hints that the current management are reaching the end of their restructuring after bringing the company out of bankruptcy could have a substantial impact on the firm’s Earnings, ability to capture some of the market (in micro-hybrids) that’s becoming available to them, and their rating.  We shall see, over the next couple of years, if it’s another false dawn in Exide’s emergence.

Elsewhere the Treasuries (-8bps), Bond Funds (+4bps) and NCAV (+1bp) books had a very limited impact on performance.

Portfolio (as at 6/30 - all delta and leverage adjusted, as appropriate)
18.9% - Bond/Absolute Return Funds (DLTNX and HSTRX)
6.5% - Value Idea Equities (THRX, and DRWI)
5.1% - Treasury Bonds (TLT)
2.8% - Energy Efficiency (AXPW, and XIDE)
0.5% - NCAV Equities
0.0% - Other Equities (none)

-1.9% - China-Related Thesis (60bps premium in EWZ Jan-13 puts)
-0.5% - Hedges/Put Options (19bps in IWM Jan-13 puts, 17bps in SPY Jan-13 puts and 12bps XLY Jan-13 puts)

-12.4% - Currencies (EUO – Short Euro)

59.0% - Cash 

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

It's Okay to Not Know...

“[T]here are known knowns; there are things we know that we know.

There are known unknowns; that is to say there are things that, we now know we don't know.

But there are also unknown unknowns – there are things we do not know, we don't know. ”

— US Secretary of Defense, Donald Rumsfeld

While I was never much of a fan of Secretary Rumsfeld, it always struck me as peculiar the people took such issue with this statement as it seems a fairly logical distillation of a rather complex thing.  Given that a number of Our Man's friends, acquaintances and contacts are in the financial world, it's even stranger that folks criticized the statement as it would seem to me that unknown unknowns could just as easily be called Black Swans.  Though, I suppose it was made in a pre-2008 world when black swans weren't as popular a topic.

So, why bring up Secretary Rumsfeld’s quote now?  Well, despite what you might hear if you have the misfortune to tune into CNBC, it’s okay to not know or have any conviction in a particular outcome.  It is however, important that you realize that you have limited conviction and behave accordingly.  We’re taught that if we do the “work” – if we research, think about and analyze a problem – we’ll find the answer (i.e. reach a conclusion in which we have conviction).  It’s those known unknowns and the pesky Black Swans (unknown unknowns) that mean this isn’t the case in reality.

I bring this up because Our Man’s portfolio continues to run relatively low exposure and the performance is where it has been all year, roughly flat.  The low exposure is a reflection of my lack of conviction; that I don’t know.  On the Equity-side, this is easy to explain – while the current positions have sufficient assets or earnings to make them ‘cheap’, most of the driver of future returns is based upon some form of change or future growth.  While I believe that you’re paying little to nothing for this growth and/or I’m more positive on the probability of its occurrence, potential size, and proximity, it’s also very likely given their uncertain nature that these factors will be influenced by the macro environment.  Thus, the positions are undersized to reflect my well-known macro skepticism.  What will cause the equity book to grow?  Well, a change in the macro conditions, a change in the risk/reward in existing names, or adding new names or a theme to the book; expect to hear more on these topics soon.

So, if I’m bearish, why are the Puts/Hedges and China thesis portfolios so small?  Well, for the following reasons: we’re not there yet and the Fed (and other Central Banks).  While my bearishness is unchanged and the economy remains relatively weak (and I think noticeably weaker than people realize) it isn’t yet absolutely weak.  As discussed before, my two favourite indicators for getting a sense of where the economy stands today are the Philly Fed’s Aruoba-Diebold-Scotti Business Conditions Index and the Chicago Fed National Activity Index. 

The second reason is the Fed who have shown a belief that throwing liquidity at problems will solve them, despite the lack of evidence that it does any more than provide a temporary sugar high while potentially creating greater distortions in the markets.  However, their willingness to do so seemingly every year (surely a sign of its outstanding success) means that there is a higher bar required (i.e. the economy must be weaker than historically) or signs of greater exogenous weakness (China and Europe) before I’m willing to increase the size.  

In short, my current level of conviction is relatively low ("I don't know") and thus the portfolio's level of exposure is low. So I'm spending my time doing two things (i) waiting for the data to change and help me build some short-medium term conviction in the existing theses, and (ii) looking into, researching, thinking about and analyzing some new ones.  When I've either built greater conviction in the existing theses or am close to putting new ones into the book, then this blog will become more lively and the portfolio's exposure and risk will start to increase.