Too soon to jump back into insurers?

We truly loved this article. The writer addresses many of the sentiments we have seen develop over the last five years. The most alarming undertone is the lack of understanding as to why the life insurance companies have had success over the last little while. A lack of understanding in any investment good or bad can put your money in jeopardy. This type of “jump on the bandwagon” investing is not just present in the insurance sector, its everywhere.

Cameron French, Reuters

7:40 AM, E.T. | March 26, 2012

Canadian

After steep losses in 2011, life insurers are suddenly among the hottest plays on the Canadian market, though the stocks may have trouble building on their gains given a murky profit outlook and recent changes in their business mix, analysts tell Reuters.

With a 13-percent rise over the past two weeks, Industrial Alliance (IAG-T 31.01 -0.09 -0.29%) leads a group that has been hit hard since the financial crisis in 2008.

The group was caught flat-footed by the stock market plunge in 2008, which caused losses on their guaranteed investment products. Since then, volatile stocks and falling bond yields have forced them to take charges to guarantee future obligations, further hitting their share prices.

A recent rise in bond yields - spurred by a market-friendly comments from the U.S. Federal Reserve this month and healthier U.S. economic data - has brought back investors eager to catch a recovering sector on the upswing.

But analysts caution that while the rise in bond yields is definitely a positive for the companies, it's too early to say they're out of the woods.

"If you buy a lifeco right now, you're making a leveraged bet that the 10-year and 30-year bond yields will tick up. That's all it is," said Peter Routledge, an analyst at National Bank Financial. "Nothing has changed over the last two weeks in terms of earnings outlook."

MARKET-RELATED LOSSES

In addition to Industrial Alliance, Manulife Financial (MFC-T 13.76 -0.2 -1.43%), Sun Life Financial (SLF-T 24.05 -0.05 -0.21%) and Great-West Lifeco (GWO-T 24.57 -0.11 -0.45%) have risen 11 percent, 12 percent and 4 percent, respectively, versus a flat performance of the benchmark S&P/TSX composite index.

Under Canadian accounting rules, life insurers must keep adjusting their projections of returns from the huge investment portfolios that back their policy obligations.

Canadian government bond yields recently hit a 2012 high, with yield on the 30-year issue rising to 2.836 percent from a record low 2.413 percent in December.

When lower stocks or bond yields reduce return projections, the insurers must take the difference out of their profits, which has led to steep quarterly losses during quarters when markets are weak.

While the companies take losses when yields fall, a flat to slightly higher market does not mean easy sailing, analysts note.

Indeed, if rates stay at their current level for the long term, the insurers would have to take more losses on longer-term obligations, meaning that rising yields are needed just to preserve the status quo.

To get to the point of a meaningful improvement in earnings expectations, a more substantial and lasting move is needed.

RBC Capital Markets analyst Andre-Philippe Hardy said interest rates need to rise 50 basis points and stock markets have to rise 8 percent in each of the next two years for the companies to meet return-on-equity estimates of 10 to 12 percent.

Over the last 10 years the market has rarely had a consistent rally that would equate to an 8 percent per year return. If the insurance industry can’t keep up with that pace, what will it mean to those profits? It seems like a rally on a specific sector just because there was a shift in sentiment. This isn’t new.

"We would not chase this rally," he said in a note, adding that he does not expect the recent market moves to have a meaningful impact on first-quarter results.

DOUBLE-EDGED SWORD

The lack of positive profit impact from the market move is largely the result of the insurers' efforts over the past two years to waterproof their results against market volatility.

Both Manulife and Sun Life have heavily hedged against both stock and bond movements and cut out products that exposed them to losses in weak markets.

This has reduced negative earnings shocks over the last year, but also means there will be less of a positive impact as markets rebound from current levels.

A lot of the profits that they were booking ... they didn't have the hedging costs built in," said David Beattie, an analyst at Moody's Investors Service. "So it's really just a question of how they regain their profitability given the constraints around the product offerings they have now."

Despite their caution, analysts agree the life insurers are priced well below what the health of their core businesses would otherwise suggest, and at current prices, the group offers compelling dividend yields.

But they also warn the recent shift in bond yields could quite easily reverse itself, meaning a wait-and-see approach is the right strategy.

"The problem is if the U.S. economy hiccups again, or something happens unexpectedly with China, or something happens with Europe, you'll have a flight back into U.S. Treasuries, and down go yields," Routledge said.

"You buy a certain amount of systemic risk totally unrelated to the business franchises that these companies have when you buy a lifeco."

In my time in the financial industry I have never seen a market so impacted by Geo-Political events. A nuclear threat in Iran, Greek Bailout, Oil Futures, and a US election to boot. Our world has become so interconnected that when one invests, they can no longer just look at a P/E ratio or a trend-line. The macro events of our world will impact the performance of even the best equity based portfolio.

Lenny Kerman is the EVP of Operations for Altaview Financial Group. Altaview’s primary concern is to provide our clients with true diversification, to lower volatility while increasing returns. Please feel free to contact us for a free consultation.

Investing: "Buy what you know" is a bad strategy

CBS Money Watch

March 23, 2012 

Original article by:Larry Swedroe 

 

We’ve all been there.  We have a gut feeling about our favourite company.  We think because we love their products or their press that we really know the company, almost as an insider. How could we go wrong? If we love the company, many others must as well. Seems like a sure thing. So, we go ahead an invest in their stock. Or, as Larry Swedroe discusses here, we work in an industry sector and we feel we know the market, the competition and all the upsides (and downsides).  Who could know better than us what the future would bring. So we make what we see as a sure investment in our sector.

Investing in the same industry as your occupation hasn't yielded better results for investors. (Image courtesy of Flickr user Phillie Casablanca)

Peter Lynch was one of the most successful mutual fund managers we've seen. One of his strongest pieces of advice was to buy what you know. In fact, the title of one of his books was "One Up on Wall Street: How to Use What You Already Know to Make Money in the Market." But is this actually good advice? The authors of the recent study, "Do Individual Investors Have Asymmetric Information Based on Work Experience?," put this theory to the test.

The goal of the study was to see if individual investors preferred "professionally close" stocks (meaning stocks of companies in fields related to their profession) and if they could outperform a benchmark essentially by buying what they know. The study also looked at the performance of investors buying stock of the companies they work for, as well as other companies near where they live. The following is a summary of their findings:

• Individuals failed to diversify their human capital, overweighting stocks in their industry of employment.
• Individuals didn't earn abnormal returns when trading professionally close stocks. On a one-year level, a portfolio of stocks related to investors' areas of expertise had a negative alpha of about 5 percent (meaning investors performed worse than the benchmark). Also, the stocks they sold outperformed the stocks they bought by about 4 percent annually.
• Individuals traded excessively in professionally close stocks, showing that investors felt more confident trading stocks of companies they knew.
• Advanced degrees didn't provide any benefit. Those with a Ph.D. didn't generate abnormal returns.
• Local proximity provided no advantage.

The authors concluded: "Our findings are consistent with both familiarity and overconfidence being the behavioral driver behind our results."

When we are dealing with money, we know that we are dealing with a complex mix of emotions.  Money is our life, it’s our past and it’s our future.  How can we expect ourselves not to be emotional when so much is riding on this one variable.  Money represents all our hopes and fears.  Money can provide us with the future we always dreamed of or it can lead us down a path of ruin.  We know that people are often overly confident about their investing acumen.  Many studies have shown that when investors are asked about their investing skill, they often over-estimate their success rate. Yet, when we look at actual returns, they never measure up to the belief that investors have about how well they perform.  This is why a financial professional is so important when making critical investment decisions.  A professional has the advantage of objectivity and brings a much need rational mind to the process.

Peter Lynch advocated buying what you know. And research into human behavior demonstrates that people prefer to bet in a context where they consider themselves knowledgeable or competent rather than in a context where they feel ignorant or uninformed. Unfortunately, as Gary Belsky and Thomas Gilovich, the authors of "Why Smart People Make Big Money Mistakes," noted: "For every example of a person who made money on an investment because she used a company's product or understood its strategy, we can give you five instances where such knowledge was insufficient to justify the investment." The results shown above demonstrate that Belsky and Gilovich got it right.

The findings from this new study provide clear evidence of behavioral biases in the investment choices of individuals and add to a large body of evidence demonstrating the general tendency of investors to hold stocks of their employers and other companies they feel they know. Unfortunately, this goes against one of the principles of portfolio theory -- diversification is the only free lunch in investing, so you might as well eat a lot of it. Keep these findings in mind the next time you're tempted to invest in what you think you know.

Remember, you are often not aware of your emotional connection to your money and your investment decisions.  It makes great sense to consult with a professional, if only for a second opinion. That move could make a difference between financial success and financial failure.

© 2012 CBS Interactive Inc.. All Rights Reserved.

Why I Am Leaving Goldman Sachs

OpEd by Greg Smith

New York Times, March 14, 2012

This is the most stunning, authentic piece we have ever read.  You can feel the disappointment, evedisgust, in his words. The breach of trust is palpable as is the consequence of such a loss of trust and integrity.

Today is my last day at Goldman Sachs. After almost 12 years at the firm — first as a summer intern while at Stanford, then in New York for 10 years, and now in London — I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.

It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

But this was not always the case. For more than a decade I recruited and mentored candidates through our grueling interview process. I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video, which is played on every college campus we visit around the world. In 2006 I managed the summer intern program in sales and trading in New York for the 80 college students who made the cut, out of the thousands who applied.

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.

At Altaview, we understand the kind of trust that clients place in us.  We also know that we have to earn that trust, day by day.  The large financial institutions have lost sight of whom they are there to serve.  They do not exist to serve their own interests. When Blankfein seriously wrote that he is doing God’s work, you know that Wall Street had truly lost their moral compass.  We are here to serve our clients’ best interest.  We are here to listen, to counsel, to help and to advise.  It all begins and ends with the client.

Over the course of my career I have had the privilege of advising two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia. My clients have a total asset base of more than a trillion dollars. I have always taken a lot of pride in advising my clients to do what I believe is right for them, even if it means less money for the firm. This view is becoming increasingly unpopular at Goldman Sachs. Another sign that it was time to leave.

How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all.

Smith is stating what we know is in the back of many clients’ minds- how can I be sure that my interests are being served. How do I know that my investment professional really gets it, really is there for me.  How can I ever be sure.  We know that is what most clients think about and that is why we believe that it is the client who has to drive the relationship.  We earn their trust each time we do what we say we’re going to do. We earn their trust each time we follow through with a commitment. We earn their trust when we tell the truth. We earn their trust when we do what’s right for the client, not what earns us the most money.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.

We understand what kind of climate we’re working in and we know how cynical clients have become. We  don’t blame them. We are cynical too. That is why we work so hard to do our due diligence. Because we want to look each client in the eye and honestly answer each question.  We don't hold anything back.  If there is risk in the investment, we’ll be the first ones to tell you.  Trust is all we really have to sell to our clients.  Anybody can sell product.  That’s the easy part.  Not everybody can authentically offer trust.

It astounds me how little senior management gets a basic truth: If clients don’t trust you they will eventually stop doing business with you. It doesn’t matter how smart you are.

These days, the most common question I get from junior analysts about derivatives is, “How much money did we make off the client?” It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave. Now project 10 years into the future: You don’t have to be a rocket scientist to figure out that the junior analyst sitting quietly in the corner of the room hearing about “muppets,” “ripping eyeballs out” and “getting paid” doesn’t exactly turn into a model citizen.

When I was a first-year analyst I didn’t know where the bathroom was, or how to tie my shoelaces. I was taught to be concerned with learning the ropes, finding out what a derivative was, understanding finance, getting to know our clients and what motivated them, learning how they defined success and what we could do to help them get there.

My proudest moments in life — getting a full scholarship to go from South Africa to Stanford University, being selected as a Rhodes Scholar national finalist, winning a bronze medal for table tennis at the Maccabiah Games in Israel, known as the Jewish Olympics — have all come through hard work, with no shortcuts. Goldman Sachs today has become too much about shortcuts and not enough about achievement. It just doesn’t feel right to me anymore.

I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm — or the trust of its clients — for very much longer.

Hats off to Greg Smith for his strong moral character and the guts to stand up and say what needed to be said.

OOPS. They’re doing it again.

In an article published in the New York Times, it looks like Wall Street is back at it.   In the drive for returns, they are jumping right back into the risky investments which they had chased previously. We know how that ended; crash and burn. Some Wall Street investors made money as the mortgage market boomed; others profited when it fell apart.  One Wall Street star thinks he knows better.

Having reaped big gains during both of those turns, Greg Lippmann, a former star trader at Deutsche Bank, is now catching the next upswing: buying the same securities built from mortgages that he bet against before the financial crisis erupted.  

Mr. Lippmann is joined by other big-money investors — mutual funds like Fidelity as well as hedge funds in riding a wave of interest in the same complex loan pools that nearly washed away the financial system.

The attraction is the price. Some mortgage bonds are so cheap that even in the worst forecasts, with home prices falling as much as 10 percent and foreclosures rising, investors say they can still make money.

“Given its significant underperformance in 2011, we believe the product is as cheap to broader markets as it has been in a long time,” Mr. Lippmann, whose portfolio is heavy with subprime mortgage securities, wrote in a recent letter to investors.

I

n these uncertain times, how does an investor really assess the integrity of the trader and the markets.  One way is for investors to take a close look at the market and make their own assessment of the market.  Would you rather invest in Mr. Lippmann’s optimism? Or in something much more real. Something you can relate to.  Something that you can relate to- like real estate.

More broadly, the nascent recovery in the mortgage bond market supports a view that the housing slump may have bottomed out. Sales of existing homes are picking up. State and federal authorities have reached a $26 billion settlement with the big banks that is expected to provide some mortgage relief. And the Federal Reserve Bank of New York has been able to auction off billions of dollars of mortgage securities that it acquired as part of the financial crisis bailouts.

“There is light at the end of the tunnel,” said Kenneth J. Taubes, the head of United States investment for Pioneer Investments, a global investment manager that owns these securities. “The mortgage crisis is getting behind us, and things are getting back to some semblance of normality.”

That optimism is an about-face from 2006 and 2007, when Mr. Lippmann and others told investors that housing was a bubble ready to burst. On Wall Street, Mr. Lippmann became known as “Bubble Boy,” and one of his traders wore a joking T-shirt that read, “I Shorted Your House.”

His exploits were chronicled in Michael Lewis’s best seller “The Big Short,” which described him as somewhat brash and crass. He was known for maintaining a sushi spreadsheet, where he ranked the top Japanese restaurants in Manhattan on ambiance, quality and cost.

These days, industry competitors describe Mr. Lippmann, who runs LibreMax Capital, as a more mellow presence. And he is much more positive about the market, telling investors that his fund is reducing its hedge against a potential market crash. Through a spokesman, Mr. Lippmann declined to comment.

Once again, they’re pulling out their crystal balls. Haven’t we heard these predictions before?  As Larry Swedroe says in What Wall Street Doesn’t Want You To Know: “ The primary objective of most financial publications is not to make their readers wealthy, but to get their readers to buy more of what they’re selling- magazines.” The only way an investor can get around this is by being an informed investor.  Do your due diligence and make sure that you ask the right questions. If you don’t know what those questions should be, do your research. 

Others in the industry are also bullish, pouring money back into mortgage securities. Trading has surged in recent weeks. 

Prices have risen more than 15 percent in the first two months of 2012, after dropping by as much as 40 percent last year.

“There was a lot of money waiting on the sidelines because yields were starting to look very attractive,” said Jasraj Vaidya, a strategist at Barclays Capital. “Lots of it seems to have come out now.”

Yet the tide could turn again and wipe out investors. Chief among the risks is Europe: the Continent’s banks still hold a significant amount of United States mortgage securities, and if they are forced to sell assets, it could wreak havoc on the market.

Washington is a question mark, too. If banks have to pay for loans they issued under dubious circumstances, it would be a home run for investors, who could receive full payment for a mortgage in a security they bought at a discount. But if borrowers whose houses are worth less than their mortgages are able to reduce their principals on a large scale, bond investors could suffer because the securities would be worth even less than they paid.

“As a money manager, you can’t close your eyes to that potential outcome,” said Jeffrey Gundlach, a founder of DoubleLine Capital, who has been buying mortgage securities since 2008. “To believe that this time we are really out of the woods and the prices will not drop again is dangerous. People made that argument a year ago.”

Finally, some commonsense.  We support an informed client. In fact, we prefer that.  We want our clients to succeed and the more we can do to educate them, the better we can serve them.

The mortgage bond market is a very different creature than it was before the financial crisis. For one, it is much smaller: very few residential mortgage-backed securities have been issued since the crisis. The market, at $1.3 trillion, is half the size it was at its peak and shrinks by an estimated $10 billion every month.

Despite the limited supply, prices remain cheap, in part because the assets are difficult to value. Hedge funds and big investors use computer systems to analyze the underlying loans and estimate, among other things, how many borrowers will default and how much money can be recovered in a foreclosure.

Take one security, JPALT 2006-S1 1A11, which was built from Alt-A loans, or mortgages that required little documentation verifying a borrower’s income.

On the surface, the numbers are not encouraging: of the 799 mortgages underpinning the bond, many in foreclosure-heavy California and Florida, about 21 percent are more than 60 days late on payments.

The annual default rate is about 7 percent, and of the homes sold out of foreclosure, investors take a 54 percent hit, according to data from Bloomberg. On average, about 5 percent of the homeowners refinanced their mortgages before they were due over the last 12 months.

That bond recently traded at nearly 70 cents on the dollar.

At that price, even if defaults and the losses increase, an investor can still make more than 5.4 percent, an analysis shows. In a rosier prediction, where defaults drop slightly and the losses on the sale of foreclosed homes stay flat, the bond returns nearly 8.7 percent.

“Price is a wonderful thing,” said Chris Flanagan, an analyst with Bank of America Merrill Lynch. “Yields in this market range anywhere from 4 or 5 percent up to 12 percent.”

With long-term interest rates close to zero, such returns are hard to resist — even for investors who were punished in the housing bust. The American International Group, whose mortgage securities were acquired by the New York Fed in its more than $100 billion bailout in 2008, has been buying back some of those bonds. And a former mortgage team from Lehman Brothers, which went bankrupt in 2008, formed One William Street, a hedge fund that manages more than $3 billion in assets.

As for Mr. Lippmann, his reputation has made it both easier and more difficult to get commitments from investors. Some are impressed by his well-publicized bet against the mortgage market; others are turned off by his high profile in an industry known for secrecy and discretion.

LibreMax, made up of several members of Mr. Lippmann’s team from Deutsche Bank, has raised more than $1 billion in a little over a year. His performance has been relatively strong during a period of market turmoil — up 2 percent last year and a little more than 6 percent since launching.

Like his rivals, Mr. Lippmann cites his experience in the housing market — including its boom and bust — as a principal selling point for his fund.

“Because we have a trading history, I think we understand very well how the street works, better than perhaps people who didn’t work in trading before that haven’t had that experience,” he said at a Bloomberg hedge fund conference in 2010.

As George Sauter of the Vanguard Group says, “even if you identify the managers who have had good past performance, there’s no guarantee that they’ll have good future performance.”  It’s important that investors pay attention to the market, take the time to really understand what they are investing in and make sure the investment aligns with their personal goals and objectives. Not every investment suits every investor and you need to know what is right for you.  Nobody can determine this for you.  You are the person who has to take the time to look at your circumstances, current and future, and determine what is right for you.