Agora Financial’s Rude Awakening

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Dubai, UAE

• Portfolio managers strap in for a spot of BASE jumping,
• Your $283, non-refundable loan to AIG,
• A curious disconnect between “talk” and “walk,” and plenty more…

Eric Fry, reporting from Laguna Beach, California…

Better to have loved and lost, the saying goes, than never to have loved at all.

Oh really? Try telling that to a Chicago Cubs fan…or to Bonnie Parker…or Anne Boleyn….or Jennifer Anniston…or an AIG shareholder? In all likelihood, the author of this phrase never loved or lost anything more precious than a vintage edition of “Popular Mechanics.”

The losing end of an ardent passion is usually a very bad place to be…sometimes a very, very bad place to be, as Bill Miller, portfolio manager of the ailing Legg Mason Value Trust, knows all too well. For the last several months, the shareholders of the Value Trust have been paying a heavy price for Miller’s unwavering devotion to stocks like eBay, Google and Citigroup.

But the shareholders’ woes do not end there. Miller has also been holding a candle – several actually – for ill-fated financial stocks like Freddie Mac and AIG. As of June 30, Miller had devoted nearly 6% of his fund to these two sweethearts. Sadly, these romances are not working out too well. Miller’s fund has plummeted more than 36% year-to-date, and more than 44% since the stock market topped out last October.

When Bill Miller first fell in love with Freddie, the enraptured portfolio manager probably imagined a long and happy relationship together. And even after Freddie spurned Miller’s affection by tumbling in price, the fund manager refused to turn his back. Instead, Miller dutifully and regularly added to his holdings. Quarter after quarter, Miller stood by Freddie. Quarter after quarter, the stock continued falling until, finally, it fell into the arms of the U.S. Treasury.

So let the poets write whatever nonsense they wish, in the financial markets it is WORSE to have loved and lost. And that’s why most successful investors avoid love altogether. They will love a stock only for as long as the stock loves them back…and not a minute longer. As one day-trader friend used to joke, “I’m investing for a good time, not for a long time.”

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Cliff-Jumping
By Eric J. Fry

“I don’t care WHAT ‘all the other kids’ are doing! You’re not doing it!” your editor’s mother would often exclaim. “If all the other kids jumped off a cliff, would you?” Your editor always found himself defenseless in the face of this unassailable logic. He had to admit, he would not jump off a cliff, even if all the other kids were doing it. Some 40 years later, he has discovered that this unassailable logic is not as unassailable as it seemed during childhood. Lots of kids jump off of cliffs every day, simply because all the other kids are doing it. We call these cliff-jumpers, “portfolio managers.”

Every single trading day, the nation’s portfolio managers leap from the precipice of prudence into the abyss of group-think and “closet indexing.” They leap because everyone else is leaping. But do not pity them; pity their clients. Imprudence rarely imperils a portfolio manager’s seven-figure livelihood, even though it imperils client net worth. Most portfolio managers have come to peace with this inconvenient moral tension.

Every portfolio manager in America understands that his paycheck is secure, as long as his performance does not stray from the herd. He can lose hundreds of millions – or even billions – of client dollars, as long as all of his peers are doing the exact same thing at the exact same time. In other words, “professional money management” is much more about the professionals than it is about the money management.

Consider this recent curiosity from within the halls of Oppenheimer Co.:

Fortune’s latest “cover girl,” Meredith Whitney, is an analyst for Oppenheimer Co. She won praise from the popular financial magazine as the “Woman who called Wall Street’s meltdown.” Too bad she didn’t also call her colleagues over in the investment management division and share her prescient observations with them. Or maybe she did call and her colleagues simply ignored her.

Whatever the case, a couple of Oppenheimer’s marquee equity funds have maintained a hefty weighting to the financial sector for more than a year… and have paid a hefty price for doing so. This curious divergence between talking the talk and walking the walk begs the question: who benefited from Meredith Whitney’s brilliant call? If the Oppenheimer portfolio managers who attend the same corporate picnics as Ms. Whitney did not heed her call, who else would have?

We do not raise these questions to poke fun at Wall Street; we raise them to excoriate Wall Street.

“Whitney’s rise to prominence began last October,” Fortune Magazine relates, “when she dropped jaws from New York to London with her audacious (yet spot on) prediction that Citigroup would be forced to cut its dividend to prop up its leaky balance sheet. She followed that call with forecasts of more losses and write-downs at the likes of Bank of America, Lehman Brothers and UBS, as well as some insightful tangents on how the implosion of the bond insurers would threaten banks’ bottom lines.”

Bravo for Meredith! But wouldn’t Oppenheimer’s clients have been much happier to see Ms. Whitney make an incorrect BULLISH call on the financials, while the folks who actually managed their money made the correct bearish call?

Unfortunately, that’s not how the Wall Street money management game is played. Prudence is as welcome in the money management business as morality in a whorehouse.

Almost no fund manager on Wall Street would dare to steer clear of any obvious disaster-in-the-making, just to protect client assets. After all, the disaster-in-the-making might rally a bit before imploding, just like the financials did during the late September and early October rally of 2007.

“Risk,” in the perverse lexicon of Wall Street money management practices means simply: “divergent performance.” It does not mean: “willingly embracing a high probability of capital destruction.”

As faithful Rude readers will recall, your editors made the same “call” that Ms. Whitney made. But our call wasn’t really a call at all. It was a yellow-bellied retreat. We got scared and ran. In dozens of columns and/or speeches during the last 24 months, we urged investors to avoid financials… and also to avoid the temptation to bottom-fish in the sector. Not because we were so smart, but because we were so afraid…And because we had the luxury of ignoring benchmarks.

We care deeply about benchmarks, of course, just not the same ones that drive Wall Street’s wacky investment agenda. The benchmarks that concern us the most reside in the Beatitudes of the New Testament. But we also possess a recurring interest in the benchmarks established by Cosmopolitan Magazine’s periodic survey: “Rate your lover?”

On Wall Street, however, the “investment benchmark” is king. Or rather, it is the tail that wags the investment dog.

One particular anecdote tells the tale. About one year ago, an investment adviser known to your editor instructed one of the Wall Street portfolio managers overseeing his clients’ assets to “sell all financial stocks” in the portfolio. The portfolio manager agreed to do so, but not before insisting that the advisor’s client, a foundation, sign a waiver acknowledging the unique risks that this decision imparted. In other words, the portfolio manager didn’t want to assume any responsibility for the poor relative investment performance that “underweighting financials” might have caused.

The results of this “risky” asset allocation decision have been nothing short of breathtaking. During the 12 months ending June 2007, the portfolio manager delivered a loss of nearly 20% to all of its other clients. But over the identical time frame, the foundation’s portfolio lost only 1.3%, simply because it contained no financial stocks. That’s a difference of more than 18%… or what we call, “real money.”

So if you’re wondering why your mutual fund performed so poorly during the last 12 wants, wonder no more. The kids with your money are jumping off cliffs. Everyone’s doing it!

[Joel’s Note: If you are interested in casting your wealth off the precipice along with all the “cool kids,” we highly recommend you stay away from Dan Amoss’ Strategic Short Report. His readers will be playing the kind of downside that just saw them hit Lehman puts out of the park for 462%. More info on Dan’s unfashionably prudent short strategy can be found here.

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Did You Notice…? AIG-Whiz!
By Eric J. Fry

I just loaned $283 to AIG…I and every other American. And the funny thing is; no one asked our permission. The Federal Reserve simply took our money and handed it to a group of individuals who have demonstrated the ability to lose billions of dollars faster than almost anyone on the planet.

I would rather have tossed the money in a wishing well…not only for the wishes, but also because the wishing well will repay the loan sooner. The Fed’s $85 billion “investment” in AIG is just the latest chapter of the American financial tragedy – a sordid tale that begins with the extreme greed of a few and ends with the widespread suffering of the many.

The Fed did what it had to do. It protected the millions of individuals and institutions who relied on the insurance policies of one of the world’s largest insurance companies. But let’s hope the tragedy does not end with an $85 billion bailout. Let’s hope our sordid story contains a few more tragic chapters, like ones that feature tales of AIG’s executive officers shedding tears of remorse on their prison dungarees.

Retribution cannot return the billions of dollars that innocent individuals have lost, but it can compensate somewhat for all of our $283 loans. To quote John Lennon, “You may say I’m a dreamer, but I’m not the only one.”

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[Rude Endnote: The bloodletting has temporarily abated in Europe and Asia this morning. Most indexes traded slightly higher with London’s FTSE and Japan’s Nikkei up 1.4% and 1.2% respectively. The Chinese are still copping a beating though. After a brutal session on Tuesday, when the Hang Seng sunk over 1,000 points, it’s off another 600 or so today.

How has your portfolio manager managed your money during Wall Street’s ongoing turmoil? To sing the praises of your manager or publicly denounce their stupidity, flick us an email at the address below.

Until tomorrow…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com