Investorial

There is a lot of focus in the Canadian financial services industry on income trusts lately? Ever since the late 2000 market crash, income trusts have been the darling of Canadian investors, promising tax efficiency and steady cashflow returns. However, the last few months have seen more turmoil for the asset class. Here are a few recent articles for your reading enjoyment

• Heating Oil Partners - 1^st Canadian Income Trust to file for bankruptcy
• Canadian Finance Minister to review income trust structure
• Globe & Mail article about income trust taxation review

Many companies such CanWest Global are preferring to go to market as income trusts. Investors are calling for companies to restructure themselves. A good example was when investors were calling out for Wendy’s to spin out Tim Horton’s as an income trust. Wendy’s does not mention income trusts in their official news releases. I would even say that investor mania about the income trust structure is slowly setting in.

Two trends are quickly recognizable. Companies that have no business operating as an income trust will quickly find the payout structure hard to maintain. The federal government is also losing tax revenue because the onus for reporting income now falls onto individual investors, something that is harder and costs more to enforce for the government.

Uncertainty befalls the income trusts, and its future could be deeply impacted by the upcoming federal review.

Did you hear this? In an effort to build an in house production studio for movies based on its comic book characters, Marvel essentially mortgaged 10 of its comic intellectual property for a revolving credit line of $525 Million dollars. In return, the financier Merrill Lynch Commercial Finance Corp secured film rights to 10 Marvel characters.

Marvel was tired of sharing profit with other companies. They collaborated with Sony, in a sour deal turned lawsuit, during the “Spider-man” series. The financing deal worked out very well for Marvel. I guess nobody at Merrill Lynch is a comic book fan. Just take a look at the list of Marvel characters involved.

The only characters that have commercial viability are Captain America, The Avengers, Nick Fury, Black Panther, Cloak & Dagger and Dr. Strange. The others are merely fillers for the agreement and will most likely never see one day of movie production. Why would anybody care about Shang-Chi?

Marvel has to get high marks for pulling off a creative financing deal with the help of sub par characters. Or is it that Merrill Lynch was simply operating in unfamiliar territory?

For more details of the financing arrangement, read this article.

I recently read an update on Portus. It reported that investors who were victims of the hedge fund company’s malfeasance could recover more than the previously estimated $0.62 on the dollar. I’m happy that these investors may look forward to receiving more settlement, but this unfortunate incident should not have happened in the first place.

You can call me an investment cynic, but I think everything is a scam until I educate myself about it. Portus was a hedge fund company who sold invesments via an offering memorandum with the help of many invesment distribution channels. Investment advisors, mutual fund and insurance sales representative who referred should bear a lot of the responsibilities for their actions. So far only Manulife has really come to say that they will make restitution to clients referred to Portus through their network.

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Warren Buffett’s mentor, Benjamin Graham, introduced to the world one of the best investment analogy in Mr. Market. Mr. Market can be manic depressant today and a incorrigible optimist the next day - an extreme Jekyll and Hyde. Here is a description of the concept of Mr. Market [excerpt from About.com]

Imagine you are partners in a private business with a man named Mr. Market. Each day, he comes to your office or home and offers to buy your interest in the company or sell you his [the choice is yours]. The catch is, Mr. Market is an emotional wreck. At times, he suffers from excessive highs and at others, suicidal lows. When he is on one of his manic highs, his offering price for the business is high as well, because everything in his world at the time is cheery. His outlook for the company is wonderful, so he is only willing to sell you his stake in the company at a premium. At other times, his mood goes south and all he sees is a dismal future for the company. In fact, he is so concerned, he is willing to sell you his part of the company for far less than it is worth. All the while, the underlying value of the company may not have changed - just Mr. Market’s mood.

The best part of this entire arrangement: you are free to ignore him if you don’t like his price. The next day, he’ll show up at your door with a new one. For your interest, the more manic-depressive he is, the more opportunity you will have to take advantage of him [don't worry, he doesn't have feelings or mind being taken advantage of.] As long as you have a strong conviction of what the company is really worth, you will be able to look at Mr. Market’s offers and reject or accept them… the choice is yours.

Well, Mr. Market’s moods were certainly swinging wildly during hurricane Katrina and hurricane Rita. Yes, the hurricane did impact the operations and profit outlooks of many companies, but do you believe that the majority of the companies in the market will remember the effect of Katrina and Rita 10 years from now? Mr. Market certainly did on those days. I remember flipping the channels through CNBC, and true to the American media ways, the entire day was dedicated to covering a hurricane on a business news network! It is amazing how the media hype machine works to really affect the investors’ psyche. My advice as a value investor - don’t watch CNBC!

They say that hurricanes will be more and more common in the future due to global warming and the warm ocean waters. Does this mean that every year, the markets will swing wildly during the hurricane seasons? A value investor’s dream would include taking advantage of such mass hysteria. You cannot control how the market feels, but you can certainly be the master of your own domain!

I am a regular reader of Blog Maverick, better known as the self-made billionaire Mark Cuban. In his latest post, Mark poses the question of what defines someone to be an investor and answers himself to generate discussion among his readers.

Mark regularly writes blogs about investing. I find him both knowledgable and insightful. But more importantly, I feel he keeps an open mind and really knows what blog writing is really all about.

The post is a good primer for beginner readers to be exposed to the traditional definitions and processes of an investor. Mark uses the word speculator as a contrast/foil to an investor. I use the word trader to describe basically what is a speculator. Tometo, Tomato.

The criteria I use to separate the two types are intent. Both trader and investor and making an investment for rewards by assuming risk. However, an investor may not necessary have an exit strategy in mind; looking for the long term. Traders on the other hand, are more short term oriented, and most will have an exit strategy and parameters outlined.

I consider myself an investor because issues like shareholder rights, long term performance are more important to me. It’s important to understand what type of an investor you are? What are you? Investor or Speculator/Trader?

Related Link: Nouveau Riche University - Check out this link to view the “Investor Concierge” which features cashflow positive properties for sale nationwide! Click “guest” to gain access..

Jim Oberweis has written an article at Forbes.com to explain the economical impact of rising oil prices. I enjoy reading his explanation of how rising oil prices will have progressive effect on the economy. The 5 steps that Jim outlines reads like the theories of a course textbook, but is easily understandable by anyone.

I will briefly highlight here, the 5 oil pricing influences Jim outlined in his article.

1. Transfer of income from oil consumers to oil producers. People will buy less and it may lead to slower economic growth–maybe even a recession.
2. Cost of producing goods and services in the economy will rise, putting pressure on profit margins of companies.
3. Impact on price levels and inflation that also depends on monetary policy and the ability of the governments to maintain price stability.
4. The sum of these effects will stimulate (negatively) financial markets.
5. If the duration of the energy-price spike is not short, then the change in relative prices will create incentives for oil producers to maximize output and oil consumers to economize. Eventually dropping oil prices over the long term.

Jim also makes a few recommendations for sectors and companies to avoid, and keep track. Even though Jim runs a successful small cap investment newsletter, I feel the article is informative for everyone who wants to assess the economical impact by understanding but the advice is not necessarily suitable for everyone. Investors should not be rushing out to make changes to their portfolio just because somebody else says so. Investors who were already looking to make changes to their equity components in their portfolio, before reading this article, may find the tips more applicable.

A September 19th Forbes.com article titled “Cash Is Trash” criticizes the abundance of cash sitting on the side lines of many value fund managers. The articles writes:

Some value fund managers, flush with an influx of new money from clients, are letting it pile up rather than investing it in value stocks they view as too pricey. While they wait for a better day, other value managers say letting money sit around in cash is sinful, and they swear good buys still can be had.

My first thought about that paragraph was thinking who are these “other value managers”? Oh wait, Megan Johnston must be mentioning those fund managers that always jump on the trend of the times. Those managers who called themselves “growth managers” or “tech managers” are the same ones now declaring that they are “value managers”. The paragraph did not describe anything close to a true value manager and sets the tone for an article that caters to hype and only serves to wet the appetite of investors who will hear what they want to hear.

Megan goes on in the article to say:

Worse, the cash claque really amounts to indulging in market timing, the belief that one can know when a market turn is coming. But the market and individual stocks have fooled many a stock-picking genius before, and those faux turning points were bitterly illuminating.

I was certain that Megan does not have a clue about value investing. Value managers are indeed market timers! But Megan is still referring to that term as a growth manager would! A true value manager does not care how the overall market is performing! They are making the timing on the individual stocks on their watch lists. They are looking for an undervalued situation, an oversell, a misvaluation, a potential situation that will unlock hidden value for shareholders, and times when the markets are overreacting to bad news that do little to affect the business fundamentals.

Value managers are absolutely making their purchases based on timing! Doing this successfully requires the manager to more or less be contrarian to what the market is doing. In plain english, true value managers love the opportunity to go against the market because they are the ones who truly care about buying low - as low as possible versus the company’s intrinsic value, in order to sell high later. Therefore, the number 1 rule to engage in such practices is to always make cash preservation the highest priority!

The article does correctly state that value investing has a better proven record than any other style over the long term. The articles comments that some of the most recognized value managers of Tweedy, Clipper and Longleaf were seeing their short term performance lagging their category peers. Well, that’s the market hype machine working at its best. Value investors are not a crowd that care about short term performance. These managers are hired for their expertise in keeping and growing money over the long term and are considered some of the best.

Warren Buffett, arguably the most notable value investor, has always said that the best time to sell a stock pick is never. If you can buy a stock, allow the market to close for 10 years and still be happy about the pick, then you should buy it. Value managers more or less follow that creedo, and they view the battle as half won if they are able to pick a good entry point; hence timing on an individual company basis!

The most successful value managers have been great managers of large amounts of cash at one time or another. Megan’s article served little purpose but to show her ignorance of what true value investing really is all about.

Related Links

Forbes.com: ‘Cash Is Trash’ by Megan Johnston